hwakch27 - Econ 2 Principles of Economics Chapter 27...

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1 Econ 2: Principles of Economics Chapter 27 Questions for Review 1. If the interest rate is 7%, the present value of $200 to be received in 10 years is $200/(1.07) 10 = $101.67. If the interest rate is 7%, the present value of $300 to be received 20 years from now is $300/(1.07) 20 = $77.53. 2. Purchasing insurance allows an individual to reduce the level of risk he faces. Two problems that impede the insurance industry from working correctly are adverse selection and moral hazard. Adverse selection occurs because a high-risk person is more likely to apply for insurance than a low-risk person is. Moral hazard occurs because people have less incentive to be careful about their risky behavior after they purchase insurance. 3. Diversification is the reduction of risk achieved by replacing a single risk with a large number of smaller unrelated risks. A stockholder will get more diversification going from 1 to 10 stocks than from 100 to 120 stocks. 6. The efficient markets hypothesis suggests that stock prices reflect all available information. This means that we cannot use current information to predict future
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