Chapter 7 Flashcards
What is risk?
Risk is the probability that something will occur
What is the objective interpretation of probability?
That it relies on the frequency with which certain events tend to occur
What is the subjective interpretation of probability?
That it is the perception that an outcome will occur
What is the expected value?
It is the probability weighted average of the payoffs associated with all possible outcomes
What is the payoff?
It is the value associated with a possible outcome
What does the expected value measure?
It measures the central tendency, the payoff or value that we could expect on average
What is the standard deviation?
It is the square root weighted average of the squares of the deviations of the payoffs associated with each outcome from their expected values
What is the expected utility?
It is the sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur
What is risk averse?
It is the condition of preferring a certain income to a risky income with the same expected value
What is risk loving?
It is the condition of preferring a risky income to a certain income with the same expected value
What is risk premium?
It is the maximum amount of money that a risk-averse person will pay to avoid taking a risk
What is the relationship between risk aversion and income?
it is the extent of an individual’s risk aversion on the nature of the risk and on the person’s income. Other things being equal, risk-averse people prefer a smaller variability of outcomes
What is diversification?
iIt is the practice of reducing risk by allocating resources to a variety of activities whose outcomes are not closely related
What is a mutual fund?
It is when an organization pools funds of individual investors to buy a large number of different stocks or other financial assets
What are positively correlated variables?
They are variables that have a tendency to move in the same direction
What does “actually fair” mean?
It is the characterization of a situation in which an insurance premium is equal to the expected payout
What is the value of complete information?
It is the difference between the expected value of a choice when there is complete information and the expected value when information is incomplete
What are assets?
It is something that provides a flow of money or services to its owner
What is a risky asset?
it is an asset that provides an uncertain flow of money or services to its owner
What is a riskless asset?
It is an asset that provides a flow of money or services that is known with certainty
What is a return?
It is the total monetary flow of an asset as a fraction of its price
What is a real return?
It is a simple (or nominal) return on an asset, less the rate of inflation
What is an expected return?
It is a return that an asset should earn on average
What is an actual return?
it is a return that an asset earns
