FIN 400 Midterm Exam with Questions and
Answers
Random Walk ANSWER process in which each subsequent step is determined randomly as
opposed to based off previous events.
How do academics and professionals differ in their opinions regarding investment returns?
ANSWER Academics tend to look more at long-term investments there is more predictability
while professionals try to predict the market in the short term.
Investing vs. Speculating ANSWER Investing involves purchasing assets with less risk and a
smaller guaranteed return over a long period of time while speculating involves buying a
stock at a lower price and hoping the stock price rises to sell for a quick profit in the short
term.
a. "...to stay even, your investments have to produce a rate of return equal to inflation." Please
explain this. ANSWER The actual return is net of taxes and inflation. If return is 5% and
inflation is 5% during the same time frame, the real return is 0%.
What is the relationship between salaries and inflation? ANSWER If inflation is rising at a
greater proportion than salaries, we would begin to see a decrease in purchasing power. If
your salary is increasing at a rate slower than the inflation rate, you are becoming less
wealthy. and vise versa
What is the basic principle behind the firm foundation theory? What decision rule do you
implement when using the firm foundation theory to trade financial assets? ANSWER Every
investment instrument has a firm anchor of intrinsic value. We make predictions and
determine a present value based on expected future cash flows and level of risk. When market
prices fall below the intrinsic value, a buying opportunity arises. When they rise above
intrinsic value, a selling opportunity arises.
, What are the main problems with a model that prices dividends? (Dividend Discount Model)
ANSWER Runs a bold assumption that all earnings are used to pay out all dividends. Only
takes into account dividends, not all company's pay dividends.
What is the basic principle behind the castle in the air theory? What decision rule do you
implement when using this theory to invest? ANSWER Psychological approach to investing,
if you can predict how a crowd of investors is likely to behave in the future, you can get into
an asset before everyone else, and make more money. Buy something that you know you can
sell for a higher price than what you bought it for.
What was Keynes' opinion on firm foundation versus castle in the air? ANSWER Involves
too much work, with doubtful value.
What is the "beauty contest?" Please describe how one could be successful in the British
beauty contest. ANSWER Vote 6 prettiest faces out of 100, prize goes out to whoever voted
most similarly to rest
Predicting public opinion, your must pick whatever the "average" is. Do not vote whoever
YOU think is most beautiful, you should vote who the crowd will think is the best looking.
(castle in the air theory of investing).
What was the appeal of tulips in 1500's Holland? Which tulips were most valuable?
ANSWER Tulips were something new and interesting that has been introduced to the Dutch
by a foreigner.
The ones with the virus because they developed different colors and patterns of flames.
Answers
Random Walk ANSWER process in which each subsequent step is determined randomly as
opposed to based off previous events.
How do academics and professionals differ in their opinions regarding investment returns?
ANSWER Academics tend to look more at long-term investments there is more predictability
while professionals try to predict the market in the short term.
Investing vs. Speculating ANSWER Investing involves purchasing assets with less risk and a
smaller guaranteed return over a long period of time while speculating involves buying a
stock at a lower price and hoping the stock price rises to sell for a quick profit in the short
term.
a. "...to stay even, your investments have to produce a rate of return equal to inflation." Please
explain this. ANSWER The actual return is net of taxes and inflation. If return is 5% and
inflation is 5% during the same time frame, the real return is 0%.
What is the relationship between salaries and inflation? ANSWER If inflation is rising at a
greater proportion than salaries, we would begin to see a decrease in purchasing power. If
your salary is increasing at a rate slower than the inflation rate, you are becoming less
wealthy. and vise versa
What is the basic principle behind the firm foundation theory? What decision rule do you
implement when using the firm foundation theory to trade financial assets? ANSWER Every
investment instrument has a firm anchor of intrinsic value. We make predictions and
determine a present value based on expected future cash flows and level of risk. When market
prices fall below the intrinsic value, a buying opportunity arises. When they rise above
intrinsic value, a selling opportunity arises.
, What are the main problems with a model that prices dividends? (Dividend Discount Model)
ANSWER Runs a bold assumption that all earnings are used to pay out all dividends. Only
takes into account dividends, not all company's pay dividends.
What is the basic principle behind the castle in the air theory? What decision rule do you
implement when using this theory to invest? ANSWER Psychological approach to investing,
if you can predict how a crowd of investors is likely to behave in the future, you can get into
an asset before everyone else, and make more money. Buy something that you know you can
sell for a higher price than what you bought it for.
What was Keynes' opinion on firm foundation versus castle in the air? ANSWER Involves
too much work, with doubtful value.
What is the "beauty contest?" Please describe how one could be successful in the British
beauty contest. ANSWER Vote 6 prettiest faces out of 100, prize goes out to whoever voted
most similarly to rest
Predicting public opinion, your must pick whatever the "average" is. Do not vote whoever
YOU think is most beautiful, you should vote who the crowd will think is the best looking.
(castle in the air theory of investing).
What was the appeal of tulips in 1500's Holland? Which tulips were most valuable?
ANSWER Tulips were something new and interesting that has been introduced to the Dutch
by a foreigner.
The ones with the virus because they developed different colors and patterns of flames.
