Explain the relationship between the correlation of payoffs and the risk reducing effects of diversification and hedging.
What will be an ideal response?
Hedging is an example of a strategy to make risky activities more attractive by combining them, and, in particular, is the practice of combining two risky activities with negatively correlated financial payoffs. If two investments and thus their payoffs, are perfectly negatively correlated, together they are risk less, since the risk of each investment is offset by the other. Diversification is the practice of undertaking many risky activities, each on a small scale, rather than one or a few risky activities on a large scale. As the correlation between payoffs increases, the risk-reducing effect of diversification decreases. Diversification is thus ineffective when payoffs are perfectly positively correlated and increases in effectiveness as the payoffs approach being perfectly negatively correlated
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Interlace, Inc produces and a unique soda. The company cannot price discriminate. The figure above shows Interlace's demand curve, marginal revenue curve, and marginal cost curve. Interlace, Inc is definitely
A) a perfectly competitive firm. B) not a perfectly competitive firm. C) a natural monopoly. D) None of the above answers is correct.
At its long-run equilibrium level of output, the demand curve facing an individual perfectly competitive firm is tangent to its
A. total economic profit curve. B. long-run average cost curve. C. marginal cost curve. D. marginal profit curve.
Industrial policy aims to
a. reduce pollution by requiring factories to reduce their pollution by a certain number of tons per year. b. reduce pollution by levying a tax on factories of a certain number of dollars for every ton of pollution that the factory emits. c. encourage business firms to subsidize continuing education for their employees. d. promote technology-enhancing industries.
The foreign exchange market is where currencies are traded for one another.
Answer the following statement true (T) or false (F)