Economic And Financial Decisions Under Risk 1st Edition Louis Eeckhoudt, Christian Gollier, Harris Schlesinger - Solutions

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Comment on the responsibility of private companies under the Sarbanes-Oxley Act.
Comment on perceived benefits from Section 404 of the Sarbanes-Oxley Act.
Under the Sarbanes-Oxley Act, what must the financial statement auditor do in relation to the company’s internal control?
Comment on what Section 404 of the Sarbanes-Oxley Act requires of companies.
It is not important to know when cash is received and when payment is made. Comment.
The cash basis does not reasonably indicate when the revenue was earned and when the cost should be recognized. Comment.
Briefly explain the difference between an accrual basis income statement and a cash basis income statement.
There are five different measurement attributes currently used in practice. List these measurement attributes.
SFAC No. 5 indicates that, to be recognized, an item should meet four criteria, subject to the cost-benefit constraint and materiality threshold. List these criteria.
According to SFAC No. 2, relevance and reliability are the two primary qualities that make accounting information useful for decision making. Comment on what is meant by relevance and reliability.
Financial accounting is designed to measure directly the value of a business enterprise. Comment.
The objectives of general-purpose external financial reporting are primarily to serve the needs of management. Comment.
Briefly describe the following:a. Committee on Accounting Proceduresb. Committee on Accounting Terminologyc. Accounting Principles Boardd. Financial Accounting Standards Board
What is the FASB Conceptual Framework for Accounting and Reporting intended to provide?
Briefly describe the operating procedure for Statements of Financial Accounting Standards.
Briefly explain the term generally accepted accounting principles.
Explain the matching principle. How is the matching principle related to the realization concept?
What is the basic problem with the monetary assumption when there has been significant inflation?
Which U.S. government body has the legal power to determine generally accepted accounting principles?
Dexter Company charges to expense all equipment that costs $25 or less. What concept supports this policy?
Elliott Company constructed a building at a cost of $50,000. A local contractor had submitted a bid to construct it for $60,000.a. At what amount should the building be recorded?b. Should revenue be recorded for the savings between the cost of $50,000 and the bid of $60,000?
At which point is revenue from sales on account (credit sales) commonly recognized?
Would an accountant record the personal assets and liabilities of the owners in the accounts of the business?Explain.
Generally accepted accounting principles have substantial authoritative support. Indicate the problem with determining substantial authoritative support.
An entity may choose between the use of the accrual basis of accounting and the cash basis. Comment.
Some industry practices lead to accounting reports that do not conform to the general theory that underlies accounting. Comment.
Many important events that influence the prospect for the entity are not recorded in the financial records.Comment and give an example.
The same generally accepted accounting principles apply to all companies. Comment.
It is proper to handle immaterial items in the most economical, expedient manner possible. In other words, generally accepted accounting principles do not apply. Comment, including a concept that justifies your answer.
No estimates or subjectivity is allowed in the preparation of financial statements. Discuss.
Discuss why the concept of full disclosure is difficult to apply.
The consistency concept requires the entity to give the same treatment to comparable transactions from period to period. Under what circumstances can an entity change its accounting methods, provided it makes full disclosure?
The matching concept involves the determination of when to recognize the costs associated with the revenue that is being recognized. For some costs, such as administrative costs, the matching concept is difficult to apply. Comment on when it is difficult to apply the matching concept. What do
There are other acceptable methods of recognizing revenue when the point of sale is not acceptable. List and discuss the other methods reviewed in this chapter, and indicate when they can be used.
Inventory that has a market value below the historical cost should be written down in order to recognize a loss. Comment.
An arbitrary write-off of inventory can be justified under the conservatism concept. Is this statement true or false? Discuss.
In some countries where inflation has been material, an effort has been made to retain the significance of money as a measuring unit by adjusting the financial statements by an inflation factor. Can an accurate adjustment for inflation be made to the statements? Can a reasonable adjustment to the
Countries have had problems with the stability of their money. Briefly describe the problem caused for financial statements when money does not hold a stable value.
Which standard of measure is the best for measuring financial transactions?
Describe the following terms, which indicate the period of time included in the financial statements:a. Natural business yearb. Calendar yearc. Fiscal year
The only accurate way to account for the success or failure of an entity is to accumulate all transactions from the opening of business until the business eventually liquidates. Comment on whether this is true.Discuss the necessity of having completely accurate statements.
Because of assumptions and estimates that go into the preparation of financial statements, the statements are inaccurate and are, therefore, not a very meaningful tool to determine the profits or losses of an entity or the financial position of an entity. Comment.
Zebra Company has incurred substantial financial losses in recent years. Because of its financial condition, the ability of the company to keep operating is in question. Management prepares a set of financial statements that conform to generally accepted accounting principles. Comment on the use of
A corporation like General Motors has many owners (stockholders). Which concept enables the accountant to account for transactions of General Motors, separate and distinct from the personal transactions of the owners of General Motors?
Identify the accounting principle(s) applicable to each of the following situations:a. Tim Roberts owns a bar and a rental apartment and operates a consulting service. He has separate financial statements for each.b. An advance collection for magazine subscriptions is reported as a liability titled
The president of your firm, Lesky and Lesky, has little background in accounting. Today, he walked into your office and said, “A year ago we bought a piece of land for $100,000. This year, inflation has driven prices up by 6%, and an appraiser just told us we could easily resell the land for
How does the concept of consistency aid in the analysis of financial statements? What type of accounting disclosure is required if this concept is not applied?
Discuss the role of each of the following in the formulation of accounting principles:a. American Institute of Certified Public Accountantsb. Financial Accounting Standards Boardc. Securities and Exchange Commission
Go to the Yahoo! Finance Web site: http://finance.yahoo.com.a. Enter the name of a company in the “Get Quotes” box. Click on “Get Quotes.” Comment on what you found.b. Click on “Finance Search.” Search—“Yahoo!Finance” for—type in “Airbus”—click on“Search.” Comment on
Go to the American Institute of Certified Public Accountants (AICPA) Web site: http://www.aicpa.org.a. Click on “About the AICPA.” Click on “AICPA Mission.” Be prepared to discuss the mission of the AICPA.b. Click on “About the AICPA.” Click on“Understanding the Organization.” Click
Go to the Public Company Accounting Oversight Board (PCAOB) Web site: http://www.pcaobus.org.a. What is the mission of the Public Company Accounting Oversight Board?b. Click on “Rules.” Comment on the PCAOB’s rule-making process.
Go to the International Accounting Standards Board (IASB) Web site: http://www.iasb.org.a. Click on “About Us.” Be prepared to discuss the structure of the International Accounting Standards Board.b. Click on “About Us.” Be prepared to discuss the history of the International Accounting
Go to the SEC Web site: http://www.sec.gov.Under “Filings & Forms (EDGAR),” click on“Search for Company Filings.” Click on“Companies & Other Filers.” Enter the name of a company of your choice. Use this site to obtain the address of the company. Click on any form listed. The telephone
Go to the FASB Web site: http://www.fasb.org.a. Click on “Facts about FASB.” Be prepared to discuss The Mission of the Financial Accounting Standards Board.b. Click on “FASAC.” Read “An Overview.” Be prepared to discuss.
In this chapter, we have put the emphasis on the axioms underlying the alter native models, sothat it can beseenascomplementarytoChapter1.However, individual or collective decisions can also be analyzed with the help of the alternative models, which may produce interesting results and
Sempronius has to choose between two lotteries ˜ X and ˜ Y. Lottery ˜ X is distributed as (4, 1 4;16, 1 2;36, 1 4), whereas ˜ Y is distributed as (1, 1 2;49, 1 2).Which lottery will Sempronius prefer in each case below?(a) If he is an expected utility maximizer with u = √R, where R is the
Consideracompetitiveinsurancemarketwithadverseselectionandtwotypes ofindividuals,goodrisksandbadrisks,asproposedbyRothschildandStiglitz (1976). Assume that there are enough bad risks in the population so that an equilibrium exists. (a) Carefully explain the Rothschild–Stiglitz separating
Consider a risk-averse entrepreneur who owns a project paying x1 in state 1, with probability p1, and paying x2 in state 2, x1 >x2. The entrepreneur can hire a risk-neutral manager. The manager maximizes her expected utility, where utility is separable in wealth and effort. In particular, u(w) = w
Consider a Rothschild–Stiglitz adverse-selection economy with three (unob servable) types of consumers. In addition to the good risks and the bad risks, there also exist a medium-risk-type with loss probability pM, where pB >pM >pG.(a) Describe the separating Nash equilibrium that might exist in
Consider a competitive insurance market with adverse selection, as proposed by Rothschild and Stiglitz. We know that a pooling equilibrium will not exist.But suppose the government makes full insurance mandatory, at the fair pool ing price.Are individuals better off or worse off than they would be
BothSemproniusandJacobushavealogarithmicutilityfunctionandaninitial wealth equaling 100. They both face the idiosyncratic risk of losing 50 with probability 0.5. There exists an external insurance company that offers full insurance contracts at an actuarially unfair price. (a) Supposeinitially that
Consider an Arrow–Debreu economy with n agents and S “tradeable” states of nature. We assume that all agents have identical endowments and identical preferences. We differ here by assuming that there are S tradeable states of nature, but each agent also has a private non-tradeable, additive
Consider an Arrow–Debreu economy with n agents and S states of nature.Suppose that all agents have HARA preferences with same slope: Ti(c) =ti + bc for i = 1,...,n. Show that the equilibrium prices (i.e. the pricing kernel) is invariant to the distribution of initial claims.
Consider an economy with n risk-averse consumers with CRRA preferences and the same degree of relative risk aversion γ. Aggregate wealth at date t = 0is constant at z0. At date t = 1, aggregate wealth is z1 = z0(1 +¯g), where ¯ g is a strictly positive constant. At date t = 2 aggregate wealth
It can be shown that equation (11.9) also holds for the case where ˜ z has a continuous distribution. Suppose that (˜ z,q(˜ z)) has a bivariate normal distri bution. Stein’s Lemma states that if (˜ x, ˜ y)has a bivariate normal distribution and h(·) is a differentiable function, then cov(˜
Considerncountrieswhoseeconomiesareasymmetricallyaffectedbymacro economic risks. In each country, there is a social security system that diver sifies away the idiosyncratic component of individual risks. These countries are considering forming a federation that would unify all national social secu
Consider an economy with n + 1 agents. The first n agents have a constant relative risk aversion equaling 5, whereas the last agent is much less risk averse since she has a logarithmic utility function. Explain why it is not socially efficient for this less risk-averse agent to bear all the
Aplannerallocateswealthamongnconsumers.Theplannerknowsindividual preferences and assigns equal weight to everyone’s expected utility in making all decisions. Assume that currently the state-contingent distribution of con sumption claims is Pareto efficient. Now suppose that the planner discovers
Consideraneconomywithnrisk-averseagentsinwhicheachagentpossesses a non-tradeable zero-mean background risk ˜ εi, for i = 1,...,n. We further suppose that each ˜ εi is independent of the aggregate tradeable wealth z(˜ s)and that all agents have quadratic utility functions.(a)
An economy consists of two individuals, Sempronius and Jacobus, each with logarithmic utility. There are two equally likely states of nature. Sempronius has an endowment of 10 ducats worth of consumption in both states. Jacobus has an endowment of a contingent claim for 15 ducats worth of
Formally, the notion of WTP isobtained by fully differentiating the following equation, which implicitly defines an indifference curve for expected utility:pu(w −L)+(1−p)u(w) = C (aconstant).Total differentiation yields:WTP ≡ dw dp =u(w) −u(w −L)pu(w−L)+(1−p)u(w) .WTPis the marginal
Our discussion on prevention has many points in common with the abundant literature on the “willingness to pay (WTP1) to reduce the probability of an accident”. The WTP notion is important in cost-benefit analyses especially in the fields of health and environmental economics. This exercise and
Two neighbors, Sempronius and Ca¨ıus, have the same initial wealth of 10, which is subjected to the risk of a potential loss equal to 8. However, they greatly differ in the probability of occurrence of the loss. For Sempronius the loss has a probability of 0.40, while it is much higher for
A consumer wholives for two periods has the following intertemporal utility:U =lnc0 +lnc1.His current income is certain and equal to 10, but his future income is random and it is characterized by ˜ y1 that is distributed as (10, 1 2;14, 1 2).(a) What are the optimal value of c0 and the expected
A risk neutral firm has a very rigid production technology: either it does not produce or it produces a single quantity, say 50. Besides, because production takes time, the choice of the production level must be made before demand( ˜ D)is
Consider a two-period model of investment with Bayesian learning.The indi vidual has an initial wealth of w0 and preferences are CRRA and we assume that δ = r = 0.Theindividual must choose to invest in the risky and riskless assets at time t = 0 and t = 1.Assume that short selling of the risky
An individual with initial wealth equaling 100 has the following utility func tion:u = W 50 + 1 2W for W ⩽ 100, for W ⩾ 100.(a) Should she accept a gamble ˜ x described by (+20, 1 2;−11, 1 2)?(b) Now this individual is told that when the result of the first gamble is known, she may
An individual is endowed with a wealth of 100. In addition, she owns the gamble ˜ x1:(+20, 1 2;−20, 1 2).(a) If her utility function is u = √W, compute her expected utility.(b) What happens to this expected utility if gamble ˜ x1 is played twice, with independent draws? What happens if it is
Consider a two-period model of consumption and savings.The individual has an initial wealth of w0 and intertemporal preferences given by U(c0,c1) = u(c0) + (1 +δ)−1u(c1), where δ ⩾ 0 and u is increasing and strictly concave.Let ˜ ra and ˜ rb be two random rates of return on savings with E˜
Let us consider an economic agent who is going to live for two periods and who has the following utility function in each period:ut(ct) = ct if ct ⩽ 1000, 500 + 1 2ct if ct ⩾ 1000.His current income is y0 = 1000 and both r and δ are equal to zero.Howmuchwill this agent save at time 0:(a) if y1
(Before solving this exercise, it pays to return to the solution of Exercise 4.3.)Anindividual can allocate his saving between a safe asset (m) paying a return r and a risky one (α) with return ˜ x(E(˜ x)>r).In order to avoid heavy computations assume that y0 = y1 = y and thatδ =0.If this
Assume to start with that r = δ = 0 in a two-period model and that the utility function is quadratic, i.e.u(c) = c −βc2 with β>0and1−2βc>0sothatmarginalutilityispositiveforallrelevant values of c.(a) If y0 and y1 are certain, express the optimal values of s, c0 and c1.What happens if y0 =
An individual has the following separable lifetime utility function U =lnc0 +lnc1.(a) If y0 = 10 and y1 = 12 and if there is no credit market, measure the value of the resistance to intertemporal substitution (k). Explain why it is equal in this case to the growth rate of income.(b) Oncethere is a
Consider a market with three states of nature and three assets.The assets have the following state contingent vectors of payoffs:asset A: (2,5,7), asset B: (2,4,4), asset C: (1,0,2).Assume that all assets may be sold short.(a) Show how to synthetically construct the Arrow–Debreu securities, as
Consider an economy consisting of two risk-averse farmers, Mr. Doherty and Mr. Kessler. Both farmers plant soybeans but use different fertilization techniques.Asaresultoftheirdifferingtechniques,onlyoneplanissuccessful in any given
Consider a completemarketwithS statesofnature.Thepricing kernel is such that π1
TheReallyBigCompany,“RBC,”hasthefollowingvectorofstate-contingent end-of-period earnings: (100,60,40). State prices for the three states are Π1,Π2 andΠ3,respectively, where Π1 + Π2 + Π3 = (1+r)−1.Herer denotes the risk-free rate for borrowing or lending.(a) Express the value of the
An individual has to allocate his wealth w0 between a safe asset paying a return r and a risky one paying a return ˜ x with E(˜ x)>r.If this individual has a utility function u(w) = w − βw2 (with β>0 and 1−2βw>0forallthevaluestakenbyw sothatmarginalutility is positive).(a) Express the
Return to exercise 4.1. and assume that w = 10, h = 0.10 and d = 0.08.You should find that α∗ = 12.5. Now assume that, besides his wealth of 10, the decision maker faces a background risk ˜ ε (independent of the other risk)distributed as (+2, 1 2;−2, 1 2).(a) Write the expected utility (Eu)
An individual with a utility function u = lnw has the opportunity to invest in a risky asset whose final payoff is distributed as (1 + h, 1 2;1 −d, 1 2) with h>d.The risk-free return on bonds is zero. The initial price of the risky asset is normalized to unity.(a) Write the first order condition
Consider again the data of the previous exercise and first express the pre mium and the distribution of final wealth when the risk manager selects a deductible of 20 for each building (assume the loading is zero to simplify the computation).Now,his insurer suggests an “umbrella policy” where,
A firm owns two buildings which have the same value (W0 = 40 for each building)andwhicharesubjectedtoariskoffulllosswithidenticalprobability 14. Because these buildings are located far away from each other the risks are independent.The risk manager has a budget of 8 to spend on insurance premia in
A wealth of 10 is subjected to a random loss that has a uniform density on[0, 10].(a) Compute the premium corresponding to a deductible D = 4 (assumeλ =0).(b) Which coinsurance rate will induce the same premium?(c) Consider now a policy with a ceiling C so that:I(x)= x ifx ⩽C, C ifx ⩾C.Which
An individual owns assets of value W0 = 10, which may suffer a random loss(˜ x) described by a discrete random variable:x p(x)0 48 10 0.7 0.1 0.1 0.1(a) Compute the premium associated to full insurance (assume the loading is zero everywhere in this exercise).(b) What is the actuarially fair
Sempronius has a logarithmic utility function. He owns an asset the value of which is 12 ducats. This asset is subject to a potential loss of 8 ducats with probability 1 4.(a) Which insurance premium should Sempronius pay if he selects β = 1 and if the loading is equal to 0.2?(b) What is the
A corporation must decide between two mutually exclusive projects. Both projects require an initial outlay of 100 million euro, and they generate cash flows that are independent of the growth of the economy. Project A has an equal probability of four gross payoffs: 80 million euro, 100 million
Consider lottery ˜ X distributed as (−10, 1 3;0, 1 3;+10, 1 3) and a ‘white noise’ ˜ εdistributed as (−5, 1 2;+5, 1 2). First generate lottery ˜ Y by attaching the white noise to the worst outcome of ˜ X (i.e. −10) and then generate lottery ˜ Z by attaching the white noise instead
Besides a certain wealth of 100, Ms. A owns one house, the value of which is 80. The probability of full loss (due to fire) for this house is equal to 0.10 for a given time period and Ms. A has no access to an insurance market. In the absence of fire, the value of the house remains equal to its
Let ˜ X be a binomial random variable with n = 2 and p = 1 2, while ˜ Y is also binomial but with n = 3 and p = 1 3.(a) Draw their cumulative distribution functions. Is ˜ Y riskier than ˜ X in the sense of Rothschild and Stiglitz?X.)(b) Compute σ2 for ˜ X and ˜ Y. (You should of course
Consider the following two random variables: ˜ X has a (continuous) uni form density on [−1,+1], while ˜ Y is a discrete random variable defined by (−1, 1 2;+1, 1 2).(a) Do ˜ X and ˜ Y have the same mean?(b) Compute their variances.(c) Draw their cumulative distributions.(d) Which random

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Economic And Financial Decisions Under Risk 1st Edition Louis Eeckhoudt, Christian Gollier, Harris Schlesinger - Solutions

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