3.Think of a bookstore.What risks is such a business exposed to,and who bears them? Answer: Major risks: Risk that inventory will not arrive on time Risk that employees will be late or absent Risk that computers/registers will break down Risk of new competition in the area (especially-the "superstores") Risk that distributors'prices will increase dramatically These risks are borne by shareholders,owners,employees,creditors,customers, suppliers. 4.Explain why the sale/purchase of a house is similar to a forward contract in nature. Answer: Both parties eliminate the uncertainty associated with price volatility in the housing market during the months of settling the contract between them.Even though the transfer of ownership for the house won't happen for many months,the buyer and seller of a house can contractually settle on a transaction price for the house. 5.Explain the difference between insuring and hedging. Answer: When you hedge,you eliminate the risk of loss by giving up the potential for gain. However,when you insure,you pay a premium to eliminate the risk of loss and retain the potential for gain. 6.Discuss the two factors limiting the efficient allocation of risks. Answer: Transactions costs and incentive problems are the two key factors limiting the efficient allocation ofrisks.Transactions costs include the costs ofestablishing and running institutions such as insurance companies or securities exchanges and the costs of writing and enforcing contracts. Moral hazard and adverse selection are examples of incentive problems,which stand in the way of the development of institutions for efficient risk sharing.Moral hazard exists when having insurance against some risk causes the insured party to take greater risk or to take less care in preventing the event that gives rise to the loss. The problem with adverse selection relates to the fact that those who purchase insurance against risk are more likely than the general population to be at risk. 10-1010-10 3. Think of a bookstore. What risks is such a business exposed to, and who bears them? Answer: Major risks: Risk that inventory will not arrive on time Risk that employees will be late or absent Risk that computers/registers will break down Risk of new competition in the area (especially - the “superstores”) Risk that distributors' prices will increase dramatically These risks are borne by shareholders, owners, employees, creditors, customers, suppliers. 4. Explain why the sale/purchase of a house is similar to a forward contract in nature. Answer: Both parties eliminate the uncertainty associated with price volatility in the housing market during the months of settling the contract between them. Even though the transfer of ownership for the house won't happen for many months, the buyer and seller of a house can contractually settle on a transaction price for the house. 5. Explain the difference between insuring and hedging. Answer: When you hedge, you eliminate the risk of loss by giving up the potential for gain. However, when you insure, you pay a premium to eliminate the risk of loss and retain the potential for gain. 6. Discuss the two factors limiting the efficient allocation of risks. Answer: Transactions costs and incentive problems are the two key factors limiting the efficient allocation of risks. Transactions costs include the costs of establishing and running institutions such as insurance companies or securities exchanges and the costs of writing and enforcing contracts. Moral hazard and adverse selection are examples of incentive problems, which stand in the way of the development of institutions for efficient risk sharing. Moral hazard exists when having insurance against some risk causes the insured party to take greater risk or to take less care in preventing the event that gives rise to the loss. The problem with adverse selection relates to the fact that those who purchase insurance against risk are more likely than the general population to be at risk