THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
1. A situation in which a decision maker knows all of the possible outcomes of a decision and also
knows the probability associated with each outcome is referred to as
a. certainty.
b. risk.
c. uncertainty.
d. strategy.
2. Which of the following methods of selecting a strategy is consistent with risk averting
behavior?
a. If two strategies have the same expected profit, select the one with the
smaller standard deviation.
b. If two strategies have the same standard deviation, select the one with the
smaller expected profit.
c. Select the strategy with the larger coefficient of variation.
d. All of the above are correct.
3. Which one of the following does measure risk?
a. Coefficient of variation
b. Standard deviation
c. Expected value
d. All of the above are measures of risk.
4. If a person's utility doubles when their income doubles, then that person is risk
a. averse.
b. neutral.
c. seeking.
d. There is not enough information given in the question to determine an answer.
5. Strategy A has an expected value of 10 and a standard deviation of 3. Strategy B has an
expected value of 10 and a standard deviation of 5. Strategy C has an expected value of 15
and a standard deviation of 10. Which one of the following statements is true?
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
a. A risk averse decision maker will always prefer A to B, but may prefer C to A.
b. A risk neutral decision maker will always prefer C to A or B.
c. A risk seeking decision maker will always prefer C to A or B.
d. All of the above are correct.
6. The coefficient of variation measures
a. the risk per unit of expected payoff.
b. the risk-adjusted expected value.
c. the payoff per unit of risk.
d. a decision maker's risk-return tradeoff.
7. A situation in which a decision maker must choose between strategies that have more than
one possible outcome when the probability of each outcome is unknown is referred to as
a. diversification.
b. certainty.
c. risk.
d. uncertainty.
8. If a decision maker is risk averse, then the best strategy to select is the one that yields the
a. highest expected payoff.
b. lowest coefficient of variation.
c. highest expected utility.
d. lowest standard deviation.
9. Circumstances that influence the profitability of a decision are referred to as
a. strategies.
b. a payoff matrix.
c. states of nature.
d. the marginal utility of money.
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
10. The marginal utility of money diminishes for a decision maker who is
a. a risk seeker.
b. risk neutral.
c. a risk averter.
d. in a situation of uncertainty.
11. A strategy that yields an expected monetary payoff of zero is called a
a. risk-neutral strategy.
b. fair game.
c. zero-sum game.
d. certainty equivalent.
12. A risk-return tradeoff function
a. shows the minimum expected return required to compensate an investor for
accepting various levels of risk.
b. slopes upward for a risk averse decision maker.
c. is horizontal for a risk neutral decision maker.
d. All of the above are correct.
13. If the market interest rate is 10% and a decision maker's risk adjusted discount rate is 12%,
then the decision maker
a. is risk averse.
b. has a certainty-equivalent coefficient that is greater than one.
c. is risk neutral.
d. None of the above is correct.
14. Fred is willing to pay $1 for a lottery ticket that has an expected value of zero. This proves
that Fred
a. is risk averse.
b. has a certainty-equivalent coefficient that is equal to one.
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
c. is risk neutral.
d. None of the above is correct.
15. The analysis of a complex decision situation by constructing a mathematical model of the
situation and then performing a large number of iterations in order to determine the
probability distribution of outcomes is called
a. sensitivity analysis.
b. expected utility analysis.
c. simulation.
d. a decision tree.
16. A payoff matrix presents all the information required to determine the optimal strategy using
the
a. expected value criterion.
b. the maximin criterion.
c. the utility maximization criterion.
d. simulation criterion.
17. Which of the following is a way to deal with decision making under uncertainty?
a. Simulation
b. Diversification
c. Acquisition of additional information
d. Application of the maximin criterion
18. A matrix that, for each state of nature and strategy, shows the difference between a strategy's
payoff and the best strategy's payoff is called
a. a maximin matrix.
b. a minimax regret matrix.
c. a payoff matrix.
d. an expected utility matrix.
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
19. The sequence of possible managerial decisions and their expected outcome under each set of
circumstances can be represented and analyzed by using
a. the minimax regret criterion.
b. a decision tree.
c. a payoff matrix.
d. simulation.
20.
A company has used expected values to evaluate a one-off
project. The expected value calculation assumed two possible
profit outcomes which were assigned probabilities of 0.4 and
0.6.
Which of the following statements about this approach
are correct?
1) The expected value profit is the profit which has the highest
probability of being achieved
2) The expected value gives no indication of the dispersion of
the possible outcomes
3) Expected values are relatively insensitive to assumptions
about probability
4) The expected value may not correspond to any of the
actual possible outcomes.
a. 1,4
b. 2,4
c. 3.4
d. 1.3
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
22.
Mylo runs a cafeteria situated on the ground floor of a large
corporate office block. Each of the five floors of the building are
occupied and there are in total 1,240 employees.
Mylo sells lunches and snacks in the cafeteria. The lunch menu is
freshly prepared each morning and Mylo has to decide how many
meals to make each day. As the office block is located in the city
centre, there are several other places situated around the building
where staff can buy their lunch, so the level of demand for lunches
in the cafeteria is uncertain.
Mylo has analysed daily sales over the previous six months and
established four possible demand levels and their associated
probabilities. He has produced the following payoff table to show the
daily profits which could be earned from the lunch sales in the
cafeteria:
Demand level Probability Supply level
450 620 775 960
$ $ $ $
450 0·15 1,170 980 810 740
620 0·30 1,170 1,612 1,395 1,290
775 0·40 1,170 1,612 2,015 1,785
960 0·15 1,170 1,612 2,015 2,496
If Mylo adopts a maximin approach to decision-making, which
daily supply level will he choose?
A 450 lunches
B 620 lunches
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
C 775 lunches
D 960 lunches
Answer
A
The maximin rule selects the maximum of the minimum outcomes
for each supply level.
For Mylo the minimum outcomes are:
450 lunches – $1,170
620 lunches – $980
775 lunches – $810
960 lunches – $740
23
The maximum of these is at a supply level of 450 lunches.
The Mobile Sandwich Co prepares sandwiches which it delivers and
sells to employees at local businesses each day.
Demand varies between 325 and 400 sandwiches each day. As the
day progresses, the price of the sandwiches is reduced and, at the
end of the day, any sandwiches not sold are thrown away. The
company has prepared a regret table to show the amount of profit
which would be foregone each day at each supply level, given the
varying daily levels of demand.
Regret table
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
Daily supply of sandwiches (units)
325 350 375 400
325 $0 $21 $82 $120
Daily demand 350 $36 $0 $44 $78
for sandwiches (units) 375 $82 $40 $0 $34
400 $142 $90 $52 $0
Applying the decision criterion of minimax regret, how many
sandwiches should the company decide to supply each day?
A. 325
B. 350
C. 375
D. 400
Answer C
The maximum regret at each supply level is as follows:
At 325: $142
At 350: $90
At 375: $82
At 400: $120
The minimum of these is $82 at 375, therefore the
answer is C.
24
Tree Co is considering employing a sales manager. Market research has shown that a
good sales manager can increase profit by 30%, an average one by 20% and a poor
one by 10%. Experience has shown that the company has attracted a good sales
manager 35% of the time, an average one 45% of the time and a poor one 20% of the
time.
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
The company’s normal profits are $180,000 per annum and the sales manager’s salary
would be $40,000 per annum.
Based on the expected value criterion, which of the following represents the
correct advice which Tree Co should be given?
A. Do not employ a sales manager as profits would be expected to fall by $1,300
B. Employ a sales manager as profits will increase by $38,700
C. Employ a sales manager as profits are expected to increase by $100
D. Do not employ a sales manager as profits are expected to fall by $39,900
A. Answer
New profit figures before salary paid:
Good manager: $180,000 x 1·3 = $234,000
Average manager: $180,000 x 1·2 = $216,000
Poor: $180,000 x 1·1 = $198,000
EV of profits = (0·35 x $234,000) + (0·45 x $216,000) + (0·2 x
$198,000) = $81,900 + $97,200 + $39,600 = $218,700
Deduct salary cost and EV with manager = $178,700
Therefore do not employ manager as profits will fall by $1,300.
25
Cement Co is a company specialising in the manufacture of cement, a product used in
the building industry. The company has found that when weather conditions are good,
the demand for cement increases since more building work is able to take place.
Cement Co is now trying to work out the level of cement production for the coming year
in order to maximise profits. The company has received the following estimates about
the probable weather conditions and corresponding demand levels for the coming year:
Weather Probability Demand
Good 25% 350,000 bags
Average 45% 280,000 bags
Poor 30% 200,000 bags
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
Each bag of cement sells for $9 and costs $4 to make. If cement is unsold at the end of
the year, it has to be disposed of at a cost of $0·50 per bag. Cement Co has decided to
produce at one of the three levels of production to match forecast demand. It now has to
decide which level of cement production to select.
Required:
(a) Construct a pay-off table to show all the possible profit outcomes. (5 marks)
ANSWERS
Cement Co
Pay off table
SUPPLY (no. of bags)
350,000 280,000 200,000
Weather $’000 $’000 $’000
Good $’000 1,750 (1) 1,400 1,000
DEMAND Average $’000 1,085 (2) 1,400 1,000
Poor $’000 325 640 1,000
26
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
27
THE AL –Hashier Educators (TAE)Notes
Risk & uncertainity SMA MCQ’S & Descriptive
28.
Gam Co sells electronic equipment and is about to launch a new product onto the
market. It needs to prepare its budget for the coming year and is trying to decide
whether to launch the product at a price of $30 or $35 per unit.
The following information has been obtained from market research:
Price per unit $30 Price per unit $35
Probability Sales volume Probability
0.4 120,000 0.3
0.5 110,000 0.3
0.1 140,000 0.4
Notes:
(1) Variable production costs would be $12 per unit for production volumes up to and
including 100,000 units each year. However, if production exceeds 100,000 units each
year, the variable production cost per unit would fall to $11 for all units produced.
(2) Advertising costs would be $900,000 per annum at a selling price of $30 and
$970,000 per annum at a price of $35.
(3) Fixed production costs would be $450,000 per annum.
(a) Calculate each of the six possible profit outcomes which could arise for Gam
Co in the coming year. (8 marks)
(b) Calculate the expected value of profit for each of the two price options and
recommend, on this basis, which option Gam Co would choose. (3 marks)
