Fin 301 Exam 1- week 1 Questions and
Answers
Three Primary Areas of Finance - Answer-1. Corporate finance : how they manage $
2. Institutions & Markets : dominate economic market
3. Investments : decisions of buying stock/market
Basic Corporate Financial Decisions - Answer-The Investment Decision: allocating
scarce resources across competing users?
The Financial Decision: raising funds to finance these projects?
The Dividend Decision: returning funds to investors?
What is the biggest financial market in the world? - Answer-currencies- US$
The Uniqueness of Capital Markets - Answer-Debt Capital Markets: raising capital ($)
by issuing bonds, interest rates reflect the base cost of capital in economy
Equity Capital Markets: raising capital by issuing stock, allocator of risk capital in
economy, essential to finance economic growth, barometer of economic health
**raising capital = core of capitalism
The role of capital markets - Answer-1. capitalism- markets allocate capital (determined
by marketplace)
2. what is the role of government? (economic freedom) (regulator- investor- market
controls)
3. the importance of market efficiency- stock price reflect stock values (operating
efficiency, information/price efficiency)
4. creating shareholder value (manage for value, attract capital)
5. current market issues (financial crisis, insider trading, high frequency trading)
economic freedom ranks - Answer-free markets: Hong Kong, Singapore, New Zealand,
UK, Canada, USA
government controlled markets: Cuba, Venezuela, N. Korea
, financial crises: the four common elements of financial crises - Answer-1. excessive
investment in an asset class
2. easy financing usually involved
3. government bailout needed
4. it will happen again in 5-10 years
Warren Buffet Case study - Answer-1. what is the stock price of BRK.A?
$310,000- no splits, 20% annual return
Famous/focused on Insurance
Keys: prefers companies to stocks, management act like owners, moats- barriers to
entry, no tech companies, generators of cash flow
4. What financial metrics does Buffet use in his analysis of companies?
% Profit Margin and % Return on Equity
Ten Principles of Finance: Principle 1- Higher Returns Require Taking More Risk -
Answer--a trade-off exists between expected returns and risks on an investment
-safe investments have low returns
-high returns require investors to take big risks
-Ibbotson and Sinquefield study of historical annual rates on various classes of
investments from Treasury Bills to stocks show the direct relationship between the
expected return of an asset and the risk associated with receiving that return
-positive relationship between risk and return
Ten Principles of Finance: Principle 2- Efficient Capital Markets are Tough to Beat -
Answer--according to theory of efficient capital markets: current stock prices reflect all
publicly available information; and stock prices react completely, correctly, and almost
instantaneously to incorporate the receipt of new information
-if the stock market is efficient, it would be useless to forecast future prices by technical
analysis and fundamental analysis
stock will react instantly, and then go back to a random walk
Ten Principles of Finance: Principle 3- Rational Investors are Risk Averse - Answer--risk
aversion means that a rational investor prefers less risk to more risk
-finance theory is based upon the assumption that investors exhibit risk averse behavior
-a risk-averse investor does not avoid risk at all cost. He takes some small risks
-as an investor, it is important to determine your risk/return profile and identify favorable
investments before investing
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