Uni slides > Rmin Final > Flashcards

Rmin Final Flashcards

(72 cards)

Study These Flashcards
1
Q

What is the difference between pure risk and speculative risk?

A

Pure risk: Chance of loss or no loss only (e.g., car accident).
Speculative risk: Chance of loss, no loss, or gain (e.g., oil price changes).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is hedging?

A

An investment to protect finances from a risky situation, often using derivatives. Not speculation—it involves offsetting a position.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is the key difference between a forward and a futures contract?

A

Futures are standardized, exchange-traded, marked-to-market daily, require margin, and reduce counterparty risk. Forwards are customized, OTC, and settled at maturity.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Give two examples of how businesses hedge against speculative risks.

A

Airlines hedge against crude-oil price increases.
2. Monsanto uses futures to hedge against soybean and corn price increases.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is a financial derivative?

A

A contract whose payoff depends on the value of an underlying asset (e.g., commodities, currency, stocks, indexes).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are the main types of derivatives?

A

Forwards
Futures
Options
Others: swaps, caps, floors

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Define a forward contract.

A

A private, OTC agreement to buy/sell an asset at a future date at a price set today. Features: no money down initially, linear payoff, counterparty risk.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Define a futures contract.

A

Similar to a forward but standardized, exchange-traded, marked-to-market daily, and requires margin. Reduces counterparty risk.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is a long forward position?

A

Obligation to buy the asset at the forward price. Protects against price increases.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a short forward position?

A

Obligation to sell/deliver the asset at the forward price. Protects against price decreases.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

How is the forward/futures price determined?

A

FW = SP X (1+c)^n
How is the forward/futures price determined?
FW = Forward Price
SP = Current spot price
c = carrying cost rate (opportunity cost of buying or selling forward rather than now)
n = number of years till maturity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is an option?

A

A derivative giving the buyer the right but not obligation to buy/sell an asset at a strike price by expiration, in exchange for a premium.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is a call option?

A

Right to buy the underlying asset at the strike price. Used to hedge against price increases.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is a put option?

A

Right to sell the underlying asset at the strike price. Used to hedge against price decreases.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

When is a call option “in-the-money”?

A

When settlement price > strike price.
Exercise only if in-the-money.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

When is a put option “in-the-money”?

A

When settlement price < strike price.
Exercise only if in-the-money.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

European vs. American options

A

European: Can only be exercised at expiration.
American: Can be exercised anytime before expiration.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Option payoff formulas at maturity

A

Call payoff: C ∗ = max(S∗−K,0)
Put payoff: P∗ = max (K− S∗, 0)
Ct = value of a call option (on a given day t)
Pt = value of a put option (on a given day t)
St = value of underlying asset, stock or commodity (on a given day t)
K = strike price (exercise price)
* = denotes the values at maturity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is an option spread?

A

Buying and selling options with different strikes to limit risk/cost (e.g., buying a call at K and selling a call at K+d).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Where are derivatives traded?

A

Over-the-counter (OTC): Customized, private.
Exchange-traded: Standardized, public (e.g., CME, TSX, CBOE).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Key features of forward contracts

A

Linear payoff
No money down initially
Settlement at maturity
Counterparty risk
Customizable (OTC)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Key features of futures contracts

A

Standardized
Daily marking-to-market
Margin required
Exchange-traded
Lower counterparty risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Define exposure, peril, and financial consequence in personal risk.

A

Exposure: Something of value that presents a chance of loss.
Peril: The event that causes the loss.
Financial consequence: The monetary impact of the loss (direct or indirect).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What are the three main personal risk treatment options?

A

Risk avoidance
Risk reduction
Risk transfer (e.g., insurance)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
How does insurance affect wealth?
With no loss: Insurance decreases wealth (due to premium paid). With a loss: Insurance increases wealth (due to claim payout). Overall: Insurance reduces the variance of potential wealth outcomes.
25
What is risk aversion?
A preference for a certain outcome over a risky one with the same expected value. A risk-averse person would decline a fair gamble (e.g., 50% chance to win/lose $1,000).
26
Define risk premium.
The extra compensation (in expected value) required by a risk-averse person to accept a risky gamble instead of a certain outcome.
27
Compare risk neutral, risk averse, and risk seeking.
Risk neutral: Only cares about expected value; no risk premium needed. Risk averse: Requires a risk premium to accept risk. Risk seeking: Would pay to take on risk (enjoys uncertainty).
28
What is actuarially fair insurance?
Insurance priced such that premium = expected loss. No profit or loading is included.
29
List five factors affecting demand for insurance.
Premium loadings Income and wealth Information (asymmetric info/adverse selection) Other sources of indemnity Non-monetary losses (pain, heirlooms, etc.)
30
What is utility theory in risk management?
A model where individuals maximize expected utility (EU), not just expected wealth. Utility functions reflect satisfaction (“utils”) from wealth levels.
31
What is certainty equivalent (CE)?
The guaranteed amount of wealth that gives the same utility as a risky prospect. Formula: u(CE) = E[u(W)]
32
What is maximum premium (MP)?
The most a person is willing to pay for full insurance: MP=Initial wealth−CE
33
What is risk premium (RP) in utility theory?
The amount by which Expected whealth less than certainty equivalent: RP=E(W)−CE Also: Expected Loss RP=MP−Expected Loss
34
What does diminishing marginal utility imply?
Each additional dollar adds less utility than the previous one. This is typical of risk-averse individuals (e.g., U(w) = Sqrt(w or ln(w)
35
How do you calculate expected utility?
E[u(W)]=∑(probability)×u(wealth outcome) Example: For a 20% chance of $40K and 80% chance of $50K: E[u]=0.2×u(40K)+0.8×u(50K)
36
What is partial insurance with a deductible?
Insurance that does not cover the full loss; the insured pays a deductible "d" out-of-pocket. Premium is lower than for full coverage.
37
What is the St. Petersburg Paradox?
A gambling game where expected monetary value is infinite, but people are only willing to pay a small amount to play—illustrating that people care about expected utility, not just expected value.
38
How does wealth affect risk aversion?
Generally, risk aversion decreases as wealth increases (wealthier people can absorb losses more easily).
39
What is adverse selection in insurance?
When individuals with higher risk are more likely to buy insurance, leading to higher premiums and market inefficiency.
40
What is non-monetary loss?
A loss that is not purely financial (e.g., pain and suffering, loss of sentimental items, loss of companionship). Affects insurance demand.
41
How does a risk-averse person decide on insurance?
By comparing expected utilities: Choose the option with the highest E[u(W)] among: No insurance Partial insurance Full insurance
42
What are employee benefits?
Non-wage compensation provided in addition to salary. Examples: group insurance, retirement plans, wellness programs, daycare, vacation, etc.
43
Why do employers offer benefits instead of just higher wages?
Tax advantages for employees Cost savings through group insurance Productivity effects (e.g., better health, morale, retention) Employee incentives (e.g., pension plans)
44
What is the tax advantage of employee benefits?
For employees: Benefits are often tax-free or tax-deferred (e.g., registered plans), unlike cash wages which are fully taxable.
45
From an employer’s tax perspective, are benefits treated differently than wages?
No. Employer costs for benefits are deductible expenses, just like wages—so no tax advantage for the employer directly.
46
Example: Helen has two options: $40K salary, no dental $39K salary + dental (worth $1K) If Helen’s tax rate is 35%, which should she choose?
Option 1: After-tax income = $40,000 × (1 – 0.35) = $26,000 Option 2: After-tax income = $39,000 × (1 – 0.35) = $25,350 + tax-free dental worth $1K She prefers Option 2 if dental value > $650.
47
How can employee benefits increase productivity?
Deferred compensation (e.g., pensions) encourages retention Improves health/morale Reduces turnover Attracts better talent
48
Who ultimately pays for employee benefits in the long run?
Employees, through reduced wages.
49
What is a contributory plan?
A benefit plan that requires employees to contribute (e.g., via payroll deduction) to qualify for benefits.
50
What is a noncontributory plan?
A benefit plan fully paid by the employer—but employees still “pay” indirectly through lower wages.
51
In the short run, who bears the cost of benefit increases?
Employers (through lower profits), until wages adjust.
52
What is deferred compensation?
Benefits paid in the future (e.g., pensions), which incentivize employees to stay with the company.
53
List common types of employee benefits in Canada.
Group health/dental/life insurance Disability income protection Retirement/pension plans Wellness/fitness programs Housing, daycare, education funding Vacation, sick leave, profit sharing
54
Why might an employee prefer benefits over equivalent cash?
Tax advantages Group pricing is cheaper Convenience and guaranteed coverage
55
How do benefits affect employee turnover?
Good benefits reduce turnover by increasing job satisfaction and making it costly for employees to leave (e.g., losing pension benefits).
56
What is the main economic explanation for employer-provided benefits?
Efficiency: Employers can provide benefits at a lower cost (group rates) and with tax advantages, making total compensation more valuable than cash alone.
57
What is linearity in forward contract payoffs?
Payoffs are symmetrical; one party’s gain equals the other’s loss.
58
What does no money down mean in forward contracts?
In theory, no money is exchanged at initiation.
59
What is daily resettlement in futures contracts?
Also called marking-to-market; gains/losses are settled daily through a clearinghouse.
60
What is margin in futures trading?
Collateral posted by parties to cover potential losses; reduces counterparty risk.
61
What is the no-arbitrage price in forward/futures pricing?
The price that prevents riskless profit; determined by supply/demand equilibrium.
62
What does a cap represent in options?
A series of call options used to hedge against price increases.
63
What does a floor represent in options?
A series of put options used to hedge against price decreases.
64
What is the payoff formula for a call option at maturity?
C ∗ =max(S ∗ −K,0)
65
What is the payoff formula for a put option at maturity?
P ∗=max(K−S ∗ ,0)
66
What is a loading in insurance pricing?
An amount added to the expected loss to cover expenses and profit; premium = expected loss + loading.
67
What is expected utility?
The weighted average of utilities across possible outcomes, used to make decisions under uncertainty.
68
What is a risk-neutral person’s utility function?
Linear utility (e.g.,u(w)=w).
69
What is a risk-averse person’s utility function example?
Concave utility (e.g., u(w)= SQRT(w) or u(w)=ln(w)
70
How do you calculate expected utility without insurance?
E[u(W)]=p⋅u(W L )+(1−p)⋅u(W NL) ​wl = Wealth in a loss state Wnl = wealth in a no loss state p = probability of loss
71
How do you calculate expected utility with full insurance?
E[u(W)]=u(W 0 −PF) — same wealth in both states. P_F: Full insurance premium W₀: Initial wealth
Uni slides
flashcards
Decks in class (8)
# Cards
Brainscape helps you reach your goals faster, through stronger study habits.
© 2026 Bold Learning Solutions. Terms and Conditions