CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz item set questions, study session 3, reading 5

Recently, Bryant gathered his portfolio management team for a discussion on behavioral finance concepts and their implications for investment management.. During the discussion, Bryant q

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CFA Level III Item-set - Question

Study Session 3 June 2018

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FinQuiz Item-set ID: 67408

Questions 1(67409) through 6(67414) relate to Reading 5

Keith Bryant Case Scenario

Keith Bryant is a senior portfolio manager at Boston Investment Management (BIM), an

investment advisory firm with a number of branches throughout the U.S Bryant works for the investment wing that targets high net worth private wealth clients Recently, Bryant gathered his portfolio management team for a discussion on behavioral finance concepts and their

implications for investment management During the discussion, Bryant quoted the following comments made by some of his clients over his ten-year portfolio management experience: Client A: “I would like you to consider my risk tolerance before constructing a portfolio for

me To be more specific, I do not want to invest in a portfolio that has an overall volatility of more than 15% In addition, I want you to maximize the returns given this risk constraint, and also to maintain a 10% allocation to cash regardless of my income level.”

Client B: “I believe that taking excessive risk with investments does not necessarily yield

high returns in the long-run Hence, I would not want to invest in any portfolio that has an expected return less two standard deviations of less than -5.0% I would also not like to invest in emerging market stocks unless they have a correlation of -0.45, or less, with my portfolio.”

Client C: “I would like you to consider my entire net worth, and then to classify my sources

of wealth into current income and current assets I would want to use my current income to meet my current living expenses and to save in order to increase my current assets This will ensure that I have enough savings for meeting my long-term goals.”

Client D: “I am glad that my employer offers a defined contribution pension plan where it

matches any contributions that I make Every year, I try to deposit 20% of my annual salary along with any extra compensation I receive in the plan to make sure I am saving for the future instead of using it all up.”

Client E: “My previous portfolio manager determined asset prices based on a detailed

calculation of fundamental risk factors For each asset, he determined a discount rate that captured all fundamental risk premiums corresponding to the asset However, I believe that the discount rate he used underestimated the true risks of the assets.”

Client F: “I want to maximize expected wealth subject to the constraint that the probability

of my wealth being less than the needed level should not exceed 5.0%.”

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1 Client A will most likely agree with which of the following assumptions?

A Investors and their advisors have perfect information and behave rationally

B Investors are not risk-averse but rather are loss-averse

C Investors have a self-control bias where they focus on short-term satisfaction instead of pursuing long-term goals

FinQuiz Question ID: 67410

2 The portfolio construction decisions of Client B are most consistent with the:

A prospect theory

B traditional finance theory

C behavioral life-cycle theory

3 Client C least likely exhibits a:

A self-control bias

B framing bias

C sentiment risk bias

4 Client D’s portfolio construction process will most likely be consistent with the:

A behavioral life-cycle theory

B behavioral portfolio theory

C behavioral SDF-based asset pricing theory

5 Client E’s approach to asset pricing is most likely consistent with the belief that:

A asset prices are inefficient

B analysts’ forecasts of an asset’s price are highly correlated

C traditional finance fails to result in the selection of wealth-maximizing or optimal

portfolios

6 Client F most likely constructs portfolios according to the:

A behavioral life-cycle theory

B behavioral portfolio theory

C traditional finance theory

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FinQuiz Item-set ID: 67419

Questions 1(67420) through 6(67425) relate to Reading 5

Analytical Investment Associates (AIA) Case Scenario

Analytical Investment Associates (AIA) is a U.S based asset management firm that specializes

in traditional stock and bond investments, as well as in alternative investments including real estate, private equity and hedge funds Pamela Cameron is the chief portfolio manager at AIA who heads a team of seven portfolio managers Due to the emerging emphasis on the application

of behavioral finance concepts to investment decisions, Cameron headed a meeting with her portfolio management team for a discussion on behavioral finance During the meeting she made the following comment:

Statement 1: “The behavior of market participants is not necessarily rational Individuals, at

times, identify with satisfactory sub-goals rather than try to achieve an optimum, and then make decisions to meet these limited objectives In addition, as

experience increases, individuals learn and apply new heuristics to changing situations.”

Cameron then presented the following investor comments to explain how individuals actually make portfolio construction decisions:

Investor A: “I construct my portfolio in layers by considering the variance of individual assets

and the covariance among the layers Also, my expectations of return and risk attitudes vary between the layers.”

Investor B: “I always hold large amounts of cash so that I do not have to meet liquidity needs

by selling assets In addition, I generally hold underperforming security positions for a considerable time, since I believe that a stock always has an ability to rebound.”

Investor C: “To take my risk attitudes into account, I always advice my portfolio manager to

limit the risk of failing to achieve my aspirational level of wealth.”

After the meeting, Michelle Baines, one of the portfolio managers, approached Cameron to talk about behavioral finance alternatives to the efficient market hypothesis and Markowitz’s

portfolio theory Cameron made the following comments:

Statement 2: “The efficient market hypothesis (EMH) assumes that individuals are risk averse,

self-interested and completely rational Under the adaptive market hypothesis (AMH), individuals do not act in their own self-interest, use heuristics, make mistakes and learn from them.”

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Cameron manages a $5 million portfolio for Dana Hart, one of her oldest clients Hart wants to make $5,200,000 and has stated a probability of not meeting this wealth level equal to 30% Also, Hart has decided that she cannot tolerate the portfolio value declining below 4.5 million dollars Cameron has constructed a portfolio for Hart that is allocated 60% to riskless assets, 20% to risky assets, and 20% to highly speculative assets The portfolio is expected to return 3.9% about 65% of the time, and it has a 0% probability of falling below $4.5 million

Cameron has invested 5% of her portfolio in the Brazilian stock market As part of her analysis

of the market, Cameron is trying to determine if stock prices move too much to be justified by subsequent changes in dividends She is also studying Brazilian capital market seasonality

7 Which of the following behavioral concepts best captures the behavior of individuals as

identified by Cameron in Statement 1?

A Prospect theory

B Bounded rationality

C AMH

8 Which of the investor comments presented by Cameron are most likely consistent with the

BPT?

A Comments by Investors A and B only

B Comments by Investors B and C only

C Comments by Investors A, B and C

9 Cameron is most accurate with respect to:

A Statement 2 only

B both statements 2 and 3

C neither Statement 2 nor Statement 2

10.Given Hart’s objectives, which of the following about her portfolio is most accurate?

A The portfolio’s safety level objective needs to be lowered

B The portfolio’s allocation to riskless assets should be increased

C The portfolio appropriately meets the aspirational goals and safety objective

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11.With respect to the Brazilian market, Cameron is most likely trying to identify:

A calendar and technical anomalies

B calendar and fundamental anomalies

C fundamental and technical anomalies

12.Which of the following least likely incorporates the concept of bounded rationality?

A Decision theory

B BPT

C AMH

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