Exam (elaborations)
FIN 400 Mid-Term Questions And Answers Latest Update
- Course
- FIN 400
- Institution
- University Of Illinois - Urbana-Champaign
FIN 400 Mid-Term Questions And Answers Latest Update
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2024/2025FIN 400 Mid-Term Questions And
Answers Latest Update
Random Walk ANS✔✔ 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?
ANS✔✔ 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 ANS✔✔ 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. ANS✔✔ 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? ANS✔✔ 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? ANS✔✔ 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)
ANS✔✔ 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.
, 2024/2025
What is the basic principle behind the castle in the air theory? What decision rule do you implement
when using this theory to invest? ANS✔✔ 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? ANS✔✔ Involves too much
work, with doubtful value.
What is the "beauty contest?" Please describe how one could be successful in the British beauty
contest. ANS✔✔ 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? ANS✔✔ 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.
How did one make money with tulip investing? What was the strategy used by tulip investors?
ANS✔✔ Call options, buy at a lower predetermined price for a premium, in hopes to exercise the
option and sell at a higher price.
What role did derivatives play during the tulip craze? Why participate in the tulip craze using
derivatives instead of just buying tulips? ANS✔✔ Derivatives allowed more people to participate
by offering a sell price at only a % of the total, allowing for less money to be paid down. Hedge your
risk by purchasing an option. Huge disadvantage is the risk of losing everything: riskier with call
options
Why did the tulip "bubble" eventually burst? What is the main lesson to be learned here? ANS✔✔
Prices went so high people started selling off their tulips, everyone started selling and the tulip value
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