finance data bank

10.5 Common Versus Independent Risk

1) Common risk is also called

A) diversifiable risk.

B) correlated risk.

C) uncorrelated risk.

D) independent risk.

Use the following information to answer the problems below.

Consider two banks. Bank A has 1000 loans outstanding each for $100,000, that it expects to be fully repaid today. Each of Bank A's loans have a 6% probability of default, in which case the bank will receive $0 for each of the defaulting loans. Bank B has 100 loans of $1 million outstanding, which it also expects to be fully repaid today. Each of Bank B's loans have a 5% probability of default, in which case the bank will receive $0 for each of the defaulting loans. The chance of default is independent across all the loans.

2) The expected overall payoff to Bank A is:

A) $5,000,000

B) $6,000,000

C) $94,000,000

D) $95,000,000

3) The expected overall payoff to Bank A is:

A) $5,000,000

B) $6,000,000

C) $94,000,000

D) $95,000,000

4) The standard deviation of the overall payoff to Bank A is closest to:

A) $689,000

B) $751,000

C) $2,179,000

D) $2,375,000

5) The standard deviation of the overall payoff to Bank B is closest to:

A) $751,000

B) $2,179,000

C) $2,375,000

D) $21,794,000

Use the information for the question(s) below.

Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has 10 separate less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $100 million in net income for Little Cure. The probability of the FDA approving a drug is 50%.

6) What is the expected payoff for Big Cure's Blockbuster drug?

A) $100 million

B) $0

C) $1 billion

D) $500 million

7) What is the expected payoff for Little Cure's ten drugs?

A) $500 million

B) $100 million

C) $1 billion

D) $0

8) What is the standard deviation of Big Cure's average net income for their new blockbuster drug?

A) $0

B) $1 billion

C) $100 million

D) $500 million

9) The standard deviation of Little Cure's average net income for their ten new drugs is closest to:

A) $50 million

B) $25 million

C) $16 million

D) $500 million