INTERNATIONAL FINANCE
Example Exam questions with answers
2021 – 2022
, 1. Why is the rationality of most people bounded and how does it influence decision making
under uncertainty?
People’s rationality is limited by the cognitive limitations of the mind, the time and information
available to make decisions. Decision involve future payoffs that are uncertain, they are random
variables.
Also, the impact on the decision depends on the risk preferences: risk averse, risk seeking or risk
neutral.
2. Illustrate the property of loss aversion in financial decision making with a graph and
explain also why loss aversion is a characteristic of financial decision making which is
inconsistent with expected utility theory.
Loss aversion is a phenomenon where people tend to strongly prefer avoiding losses to acquiring
gains. The negative feeling in case of loss is larger in absolute value than the positive value in case of
gain of the same amount.
People tend to be
risk seeking in avoiding
losses and risk averse in
acquiring gains.
Loss aversion can prevent people from making the best decisions for themselves to avoid failure or
risk. Though being risk-averse is useful in many situations, it can prevent many people from making
logical choices, as the fear of loss is too intense.
, 3. Consider that the utility of an economic agent only depends on the level of wealth. The
economic agent has to choose between two job opportunities. If she accepts opportunity
1, the future level of wealth is uncertain and she will have either a low level or a high level
of wealth. The high and low level have both a 50% probability. If the agent accepts job
opportunity 2, she will receive the average value of the low and high level of wealth.
• Which opportunity will she choose and how does this depend on the curvature of
the utility function. Illustrate the three possibilities with a graph.
It depends if she is risk averse, risk neutral or risk seeking.
• Suppose the agent no longer decides on the basis of the utility function but on the
value function as described in the prospect theory of Kahneman and Tsversky. How
does her decision change?
Under the Prospect theory, her decision will change due to the next phenomenon:
1. Anchoring
2. Loss aversion Properties included in the
3. Framing model such that the modeled
4. Mental accounting value function reflects realistic
5. Benchmarking human decision making.
6. Emotions
4. How does the decision based on a heuristic differ from the decision that a so called homo
economicus would make? Provide two examples of heuristics.
Heuristics: A Rockstar Can Do Shit Only Once
Heuristic = enabling someone to discover or learn something for themselves.
Homo economicus is a theoretical abstraction that some economists use to describe a rational
human being. In certain neoclassical economic theories, people are portrayed this way: as ideal
decision-makers with complete rationality, perfect access to information, and consistent, self-
interested goals.
Heuristics Representative Heuristic: People tend to see patterns and causal relationships in
events that are completely by coincidence.
& Availability Heuristic: access probabilities in terms of examples one can remember
Example Exam questions with answers
2021 – 2022
, 1. Why is the rationality of most people bounded and how does it influence decision making
under uncertainty?
People’s rationality is limited by the cognitive limitations of the mind, the time and information
available to make decisions. Decision involve future payoffs that are uncertain, they are random
variables.
Also, the impact on the decision depends on the risk preferences: risk averse, risk seeking or risk
neutral.
2. Illustrate the property of loss aversion in financial decision making with a graph and
explain also why loss aversion is a characteristic of financial decision making which is
inconsistent with expected utility theory.
Loss aversion is a phenomenon where people tend to strongly prefer avoiding losses to acquiring
gains. The negative feeling in case of loss is larger in absolute value than the positive value in case of
gain of the same amount.
People tend to be
risk seeking in avoiding
losses and risk averse in
acquiring gains.
Loss aversion can prevent people from making the best decisions for themselves to avoid failure or
risk. Though being risk-averse is useful in many situations, it can prevent many people from making
logical choices, as the fear of loss is too intense.
, 3. Consider that the utility of an economic agent only depends on the level of wealth. The
economic agent has to choose between two job opportunities. If she accepts opportunity
1, the future level of wealth is uncertain and she will have either a low level or a high level
of wealth. The high and low level have both a 50% probability. If the agent accepts job
opportunity 2, she will receive the average value of the low and high level of wealth.
• Which opportunity will she choose and how does this depend on the curvature of
the utility function. Illustrate the three possibilities with a graph.
It depends if she is risk averse, risk neutral or risk seeking.
• Suppose the agent no longer decides on the basis of the utility function but on the
value function as described in the prospect theory of Kahneman and Tsversky. How
does her decision change?
Under the Prospect theory, her decision will change due to the next phenomenon:
1. Anchoring
2. Loss aversion Properties included in the
3. Framing model such that the modeled
4. Mental accounting value function reflects realistic
5. Benchmarking human decision making.
6. Emotions
4. How does the decision based on a heuristic differ from the decision that a so called homo
economicus would make? Provide two examples of heuristics.
Heuristics: A Rockstar Can Do Shit Only Once
Heuristic = enabling someone to discover or learn something for themselves.
Homo economicus is a theoretical abstraction that some economists use to describe a rational
human being. In certain neoclassical economic theories, people are portrayed this way: as ideal
decision-makers with complete rationality, perfect access to information, and consistent, self-
interested goals.
Heuristics Representative Heuristic: People tend to see patterns and causal relationships in
events that are completely by coincidence.
& Availability Heuristic: access probabilities in terms of examples one can remember
