(Risk Tolerance) Flashcards

How would your best friend characterize you as a risk-taker in general? A. A real Gambler B. Willing to take risks after completing adequate research C. Cautious D. A real risk avoider

Answer: DCBA

This question assesses an individual's general risk tolerance by asking for a friend's characterization. The correct order, DCBA, arranges the options from the most risk-averse ('A real risk avoider') to the most risk-seeking ('A real Gambler'). This progression helps categorize an individual's comfort level with taking risks in various situations.

On a TV game show, you can pick one of the options below. Which one do you prefer? A. A 5% chance at winning $100,000 B. A 25% chance at winning $10,000 C. $1,000 in cash D. A 50% chance at winning $5,000

Answer: CDBA

This question evaluates risk tolerance by presenting different scenarios with varying probabilities and potential payouts. The correct order, CDBA, reflects a typical progression from a preference for a guaranteed, smaller reward (C) to increasingly riskier options with higher potential payouts but lower probabilities (D, B, A). This sequence helps gauge an individual's comfort with uncertainty and their willingness to gamble for greater returns.

You recently finished setting aside money for a "once-in-a-lifetime" trip. You lose your job three weeks before you're scheduled to depart. You would: A. Cancel the vacation B. Take a much more modest vacation C. Go as scheduled, reasoning that you need the time to prepare for a job research D. Extend your vacation, because this might be your last chance to go first-class

Answer: ABCD

This question assesses an individual's financial risk tolerance and decision-making under unexpected stress. The correct order, ABCD, represents a progression from the most cautious response ('Cancel the vacation' - A) to increasingly less cautious or more risk-taking responses (B, C, D). This sequence helps categorize an individual's comfort level with financial uncertainty and their willingness to proceed with plans despite significant changes in personal circumstances.

What would you do if you were given $20,000 to invest on the spur of the moment? A. Deposit it in a bank account, money market account, or an insured CD B. Invest it in safe high-quality bonds or bond mutual funds C. Invest it in stocks or stock mutual funds

Answer: ABC

Investing a sudden sum 'on the spur of the moment' implies a lack of prior research or a defined investment strategy. Placing the $20,000 in a low-risk, liquid, and insured option like a bank account, money market, or CD is a prudent initial step. This allows time to properly research and plan a long-term investment strategy without exposing the capital to immediate market volatility or making hasty decisions.

How at ease are you with investing in equities or stock mutual funds in terms of experience? A. Not at all comfortable B. Somewhat comfortable C. Very comfortable

Answer: BAC

This question aims to gauge an individual's self-assessed comfort and experience with stock market investments. 'Somewhat comfortable' typically indicates a moderate understanding and willingness to engage with equities, suggesting a balanced approach rather than extreme comfort (which might imply overconfidence) or complete discomfort (which might indicate high risk aversion).

Which of the following words comes to mind first when you hear the term "risk"? A. Uncertainty B. Opportunity C. Thrill D. Loss

Answer: DABC

For most individuals, especially those without extensive financial experience, the immediate and primary association with the term 'risk' is the potential for negative outcomes or 'loss.' While risk also involves uncertainty and opportunity, the psychological impact of potential loss often comes to mind first. This response helps assess an individual's inherent perception of investment risk.

Some experts are predicting prices of assets such as gold, jewels, collectibles, and real estate (hard assets) to increase in value; bond prices may fall, however, experts tend to agree that government bonds are relatively safe. Most of your investment assets are now in high-interest government bonds. What would you do? A. Sell the bonds, put all the money into hard assets, and borrow additional money to buy more B. Sell the bonds and put the total proceeds into hard assets C. Hold the bonds D. Sell the bonds, put half the proceeds into money market accounts, and the other half into hard assets

Answer: CDBA

The scenario states that most of your assets are already in 'high-interest government bonds' and that 'government bonds are relatively safe.' Despite predictions of hard asset increases, completely divesting from a safe, income-generating position based on market predictions is often too aggressive for a conservative investor. Holding the bonds maintains a stable, secure portion of the portfolio, aligning with a risk-averse strategy.

Given the best and worst-case returns of the four investment choices below, which would you prefer? (Select only one) A. $200 gain best case; $0 gain/loss worst case B. $800 gain best case; $200 loss worst case C. $2,600 gain best case; $800 loss worst case D. $4,800 gain best case; $2,400 loss worst case

Answer: ABCD

This question assesses risk tolerance by presenting options with increasing potential gains but also increasing potential losses. Choosing the option with a guaranteed non-negative outcome ($200 gain best case; $0 gain/loss worst case) indicates a highly risk-averse investor. This individual prioritizes capital preservation and avoids any possibility of loss, even at the expense of higher potential returns.

Your possessions plus $1,000 have been provided to you. You now have the option to select between: A. A 50% chance to gain $1,000 and a 50% chance to gain nothing B. A sure gain of $500

Answer: BA

This is a classic example from prospect theory, illustrating that most people are risk-averse when it comes to gains. A 'sure gain of $500' is generally preferred over a 50% chance to gain $1,000 (which has the same expected value). The certainty of the gain is more appealing than the uncertainty, demonstrating a preference for a guaranteed positive outcome.

You have all you possess, plus an additional $2,000, given to you. You now have the option to select between: A. A sure loss of $500 B. A 50% chance to lose $1,000 and a 50% chance to lose nothing

Answer: AB

This question, also related to prospect theory, assesses behavior when facing losses. While prospect theory often suggests risk-seeking behavior in the domain of losses, choosing 'A sure loss of $500' indicates a risk-averse preference. This investor prefers a smaller, certain loss over taking a gamble with a 50% chance of losing $1,000, prioritizing the avoidance of a larger potential downside.

Let's say a relative left you a $100,000 bequest and specified in their will that you invest EVERY penny in one of the options listed below. Which one would you choose? A. A savings account or money market mutual fund B. A mutual fund that owns stocks and bonds C. A portfolio of 15 common stocks D. A savings account or money market mutual fund

Answer: DBCA

When faced with a significant bequest that *must* be fully invested in one option, choosing a savings account or money market mutual fund indicates a highly conservative approach. This prioritizes capital preservation and liquidity over potential growth, reflecting a strong aversion to risk for this specific, important sum of money. It ensures the principal is safe from market volatility.

If you had to invest $20,000, which of the following investment choices would you find most appealing? A. 60% in low-risk investments 30% in medium-risk investments 10% in high-risk investments B. 30% in low-risk investments 40% in medium-risk investments 30% in high-risk investments C. 10% in low-risk investments 40% in medium-risk investments 50% in high-risk investments

Answer: ABCD

This question directly assesses an investor's preferred asset allocation and, consequently, their risk tolerance. Option A represents the most conservative allocation, with the majority (60%) in low-risk investments and only a small portion (10%) in high-risk assets. This choice indicates a preference for stability and capital protection over aggressive growth, appealing to a risk-averse investor.

A seasoned geologist who is a dependable friend and neighbor is assembling a group of financiers to support a gold exploration project. If the business is successful, the investment might be recovered 50 to 100 times over. The entire investment is useless if the mine doesn't work out. The success rate, according to your acquaintance, is barely 20%. How much would you invest if you had the cash? A. Nothing B. One month's salary C. Three month's salary D. Six month's salary

Answer: BCDA

This scenario describes a highly speculative investment with a low success rate (20%) but massive potential returns. Investing 'one month's salary' suggests a willingness to take a calculated risk with a portion of disposable income. This amount is significant enough to feel like a real investment but, if lost, would likely not jeopardize one's overall financial stability, indicating a moderate risk tolerance for speculative ventures.

Vlad the appraiser will evaluate a complex of apartments that consistently generates revenue and incurs costs. Which approach is most likely to be employed by him?

Answer: Direct capitalization

Direct capitalization is a widely used and efficient appraisal method for income-producing properties like apartment complexes with stable, consistent revenue and costs. It directly converts a property's net operating income (NOI) into a value estimate by dividing it by an appropriate capitalization rate. This approach is straightforward and suitable for properties with predictable income streams.

Shana is interested in making a purchase for a local shopping mall. What kind of trading sector does she intend to cover?

Answer: Three-mile

The 'trading sector' or 'trade area' for a shopping mall defines the geographic region from which it draws the majority of its customers. A three-mile radius is a commonly accepted and realistic estimate for the primary trade area of a local shopping mall. This distance captures the immediate surrounding population that would find the mall conveniently accessible for regular shopping.

The danger that the necessary return on investor capital won't be achieved is known as the _____ risk.

Answer: Business

Business risk refers to the inherent uncertainty in a company's operations and its ability to generate sufficient revenue to cover its operating costs and achieve its projected returns. It is the risk that a business will not be profitable enough to satisfy its investors' required return on capital. This is distinct from financial risk, which relates to a company's debt structure.