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RMI 300 Final Exam Study Guide Solutions

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RMI 300 Final Exam Study Guide Solutions Framing- How to mitigate the Bias - ANSWER-is the way we define the decision to be made. Think of a picture frame, which is a lens through which we see the situation. Some qualities are inside and some outside. -Restate/reframe the issue before making a ...

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  • November 11, 2024
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  • 2024/2025
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RMI 300 Final Exam Study Guide Solutions


Framing- How to mitigate the Bias - ANSWER✔✔-is the way we define the decision to be made. Think of

a picture frame, which is a lens through which we see the situation. Some qualities are inside and some

outside.




-Restate/reframe the issue before making a decision.


-Work towards neutral representations.


-Recognize the influence of gains versus losses; most effective concessions are those that reduce the

opponents losses, not improve an attribute in which the opponent is already "in the gains."


Retrievability/Availability: - ANSWER✔✔-People assess the frequency, probability, or likely causes of an

event by the degree to which instances of that event are readily "available" in memory


Anchoring: - ANSWER✔✔-People start with an implicitly suggested reference point (the "anchor") and

make adjustments to it to reach their estimate. A person begins with a first approximation (anchor) and

then makes adjustments to that number based on additional information.


Bounded Awareness: - ANSWER✔✔-The phenomenon by which individuals do not "see" and use

accessible and perceivable information during the decision-making process, while "seeing" and using

other equally accessible and perceivable information


Firm Value - ANSWER✔✔--present value of expected cash flow




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-Firm value is determined by expected cash flows(earnings) and required rate of return : expected return

could earn on the next best investment(affected by time and risk)


Time Effect: - ANSWER✔✔-preference for cash (to make investment) today rather than in the future




- the longer the duration until payment, the lower the value today


Risk Preference - ANSWER✔✔-preference for less risk rather than more risk all else equal


Firms Total Risk - ANSWER✔✔-A. Diversifiable (idiosyncratic, non-systematic) "basket of assets"


B. Non-Diversifiable (also called market or systematic) - can't use the law of large numbers to reduce

this.


KEY IDEA- individual investors can pool away diversifiable risk in exactly the same way that the insurers

take advantage of pooling, and pooling is ineffective for non-diversifiable risk. Therefore, RM for firms

owned by well diversified investors can only increase firm value by increasing net cash flow


being efficient adds value- why do firms buy insurance - ANSWER✔✔-- not pooling- only other option is

increasing expected CF


1.Insurer sometimes offers services more efficiently


(loss control, claims admin, investment, other)


2. Costs associated with financial distress might be reduced


3. Raising new funds may be less costly


-cost of obtaining new funds through issuing bonds, stocks, or getting a loan


-costs of using existing funds may take away from productive investments

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