2019 CFA level 3 qbank reading 9 behavioral finance and investment processes answers

Study Session 4, Module 9.2, LOS 9.d A individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it di cult to cla

Trang 1

Question #1 of 54

Which of the following is NOT a reason for excessive trading taking place in discount brokerage

accounts as compared to company retirement plans?

A) Framing bias.

B) The availability of investment options in one account as compared to the other.

C) Individuals self-selecting into one account versus the other

Explanation

Framing bias is seen in company retirement plans and can take two di erent forms: 1) when

given the choice among di erent funds to invest in the investor allocates their investments

evenly among the di erent funds which is also called 1/n nạve diversi cation and, 2) when a

company match is in the form of company stock the employee frames this as implicit advice

and subsequently allocates a higher proportion of their own contributions to the company's

stock Excessive trading is seen in discount brokerage accounts as compared to company

retirement plans Availability of more investment options in a discount brokerage account is

thought to lend itself to more excessive trading along with trading oriented individuals

self-selecting into the discount brokerage account

(Study Session 4, Module 9.2, LOS 9.c)

Related Material

SchweserNotes - Book 1

Jean Stall, CFA, has just completed the yearly review for one of her clients Je Schaller During

the review she went over the original questionnaire he lled out to make sure the current

portfolio has not drifted too far from the original asset allocation as determined by the

questionnaire The questionnaire was well designed to quantitatively determine Schaller's level

of risk aversion One of Schaller's statements in the questionnaire was that he was comfortable

investing in stocks but did not want to lose any money in the stock market As a result Stall took

a portion of his non-retirement money and put it in an indexed annuity which is a long term

investment guaranteed not to lose any money but will participate in any market gains Which of

the following is NOT an error that Stall committed?

A) There is no mention that behavioral traits were addressed in the questionnaire.

B) Stall met with Schaller on a yearly basis.

www.ombookcentre.in

Trang 2

C) Stall took Schaller’s comment too literally and may have placed him in a potentially

inappropriate product with the indexed annuity

Explanation

Stall made several errors regarding the questionnaire and subsequent meeting:

1 The questionnaire should be re-administered during the yearly review to make sureany changes in the client's circumstances are captured

2 The questionnaire should be able to identify behavioral biases displayed by the clientwhich there is no mention of this occurring

3 Stall interpreted Schaller's statement about not wanting to lose any money too literallyresulting in an inappropriate product, the annuity which is a long term retirementproduct, being used for non-retirement savings She should have inquired further intohis statement to see if he really meant not to lose any money in an investment or if he

is just overly risk averse

(Study Session 4, Module 9.2, LOS 9.b)

Trang 3

The adventurer is from the Bailard, Biehl, and Kaiser (BB&K) ve-way model which classi es

investors along two dimensions according to how they approach life in general The rst

dimension, con dence, identi es the level of con dence usually displayed when the

individual makes decisions Con dence level can range from con dent to anxious The

second dimension, method of action, measures the individual's approach to decision making

Depending on whether the individual is methodical in making decisions or tends to be more

spontaneous, method of action can range from careful to impetuous The ve behavioral

types identi ed by the BB&K ve-way model are the: adventurer, celebrity, individualist,

guardian, and straight arrow

The Pompian behavioral model identi es four behavioral investor types (BITs): passive

preserver, friendly follower, independent individualist, and active accumulator The Passive

Preserver and the Active Accumulator tend to make emotional decisions whereas the Friendly

Follower and Independent Individualist tend to use a more thoughtful approach to decision

De ning investor objectives in terms of mean and standard deviation:

A) may make it easier to estimate the probability that the objectives will be realized.

B) usually makes it less likely that the investor will deviate from the investment policy

because of current market conditions

C) may make selecting an asset allocation more di cult for the individual.

Explanation

De ning investor objectives in terms of mean and standard deviation may make selecting an

asset allocation more di cult for the individual, since it can be hard to see how the choices

a ect the probability of success In addition, this method of goal de nition often makes it can

make it di cult to estimate the probability that the objectives will be realized, and may make

it more likely that deviations from policy will occur

www.ombookcentre.in

Trang 4

Gina Arturo has an online brokerage account in which she frequently places trades Which of

the following behavioral traits is she most likely exhibiting?

A) Home bias e ect.

B) Disposition e ect.

C) Overcon dence.

Explanation

When retail investors trade their brokerage accounts excessively this is thought to be caused

by overcon dence based on a false sense of insight into the investment's future

performance The typical result is lower overall returns due to trading costs as well as from

selling winners too soon and holding losers too long Selling winners too soon and holding

onto losers too long is called the disposition e ect There is no evidence in this question that

Arturo is exhibiting the disposition e ect Many retail investors also typically display the

home bias e ect which is the behavioral trait of investors placing a high proportion of their

assets in the stocks of rms in their own country This is closely related to familiarity where

investors invest in stocks they are familiar with such as domestic stocks or their own

According to behavioral nance, which of the following best describes how investors will invest

their retirement portfolio?

A) The investor will put most of their money in the less risky assets on the menu of

their employer’s de ned contribution plan unless the employer forces them to put

B) The investor will put most of their money in the less risky assets on the menu of

their employer’s de ned contribution plan

C) The investor will put an equal dollar amount in each mutual fund on the menu of

their employer’s de ned contribution plan

Explanation

www.ombookcentre.in

Trang 5

According to behavioral nance, investors will diversify the portfolio for their de ned

contribution pension using 1/n diversi cation In 1/n diversi cation, an employee puts an

equal amount in each fund on the employer's de ned contribution pension plan menu For

example, if there are eight mutual funds available, the employee will put one-eighth of their

contribution in each fund Note that in the U.S., an employer cannot force an employee to put

more than 10% of their retirement funds in company stock

(Study Session 4, Module 9.2, LOS 9.d)

A) individuals may simultaneously display both emotional biases and cognitive errors

all the while seeming to act rationally, making it di cult to classify the individual

di b h i l bi

B) as investors age, they will most likely go through behavioral changes, usually

resulting in decreased risk tolerance along with becoming more emotional about

h i i i

C) the resulting client portfolio is not the “rational” portfolio.

Explanation

The client portfolio constructed by the adviser not falling on the e cient frontier (the rational

portfolio) is not a limitation but the result of classifying an investor into a behavioral type It

results in a portfolio that is better suited to the client given their behavioral biases

Limitations of classifying investors into the various behavioral investor types include:

Individuals may simultaneously display both emotional biases and cognitive errors allthe while seeming to act rationally, making it di cult to classify the individual

according to behavioral biases

An individual might display traits of more than one behavioral investor type, making it

di cult to place the individual into a single category

As investors age, they will most likely go through behavioral changes, usually resulting

in decreased risk tolerance along with becoming more emotional about their investing

Even though two individuals may fall into the same behavioral investor type, theindividuals should not necessarily be treated the same due to their uniquecircumstances and psychological traits

Individuals tend to act irrationally at unpredictable times because they are subject totheir own speci c psychological traits and personal circumstances In other words,people don't all act irrationally (or rationally) at the same time

(Study Session 4, Module 9.1, LOS 9.a)

www.ombookcentre.in

Trang 6

Which of the following is least likely a way to reduce overcon dence in analyst forecasts?

A) The analyst is properly self-calibrated through feedback from colleagues and

superiors along with a structure that rewards accuracy and forecasts that are

B) The analyst should seek a contrary opinion to their forecast based on evidence

along with using a large enough sample size and Bayes’ formula

C) Gather a large amount of data from which to develop a forecast.

Explanation

Collecting a large amount of data can lead to overcon dence in analysts' forecasts referred to

as the illusion of knowledge when the analyst thinks they are smarter than they are This, in

turn, makes them think their forecasts are more accurate than the evidence indicates

Self-calibration is the process of remembering their previous forecasts more accurately in

relation to how close the forecast was to the actual outcome Getting prompt and immediate

feedback through self evaluations, colleagues, and superiors, combined with a structure that

rewards accuracy, should lead to better self-calibration Analysts' forecasts should be

unambiguous and detailed, which will help reduce hindsight bias

Analysts should seek at least one counterargument, supported by evidence, for why their

forecast may not be accurate They should also consider sample size Basing forecasts on

small samples can lead to unfounded con dence in unreliable models Lastly, Bayes' formula

is a useful tool for reducing behavioral biases when incorporating new information

(Study Session 4, Module 9.3, LOS 9.e)

Typical individual investors tend not to understand the e ects of correlation on their portfolio

Which of the following characteristics of a DC plan participant's portfolio best re ects the

attempt to derive bene ts from the e ects of correlation even though the participant does not

understand those e ects?

www.ombookcentre.in

Trang 7

A) Status quo bias.

B) Familiarity.

C) 1/n diversi cation heuristics.

Explanation

Feeling that they should spread out their risk, but not knowing how leads to the 1/n

diversi cation heuristic Often times, participants will only have a rough understanding of the

e ects of correlation and diversi cation and will simply divide their assets equally over the

investment options in the plan in an attempt diversify their portfolio

This is the de nition of the disposition e ect

Which of the following is least likely to be a common bias found in analyst research?

A) The analyst makes a decision based on incomplete information knowing the

outcome could be unfavorable

www.ombookcentre.in

Trang 8

B) The analyst inappropriately tries to apply a probability to a random event.

C) The analyst nds evidence that con rms their forecast.

Explanation

Biases speci c to analysts performing research are usually related to the analysts collecting

too much information, which leads to the illusions of knowledge and control and to

representativeness, all of which contribute to overcon dence Two other common biases

found in analysts' research are the con rmation bias and the gambler's fallacy

The con rmation bias (related to con rming evidence) relates to the tendency to view new

information as con rmation of an original forecast

The gambler's fallacy, in investing terms, is thinking that there will be a reversal to the

long-term mean more frequently than actually happens A representative bias is one in which the

analyst inaccurately extrapolates past data into the future An example of a representative

bias would be classifying a rm as a growth rm based solely on previous high growth

without considering other variables a ecting the rm's future

Heather Jones graduated from a prestigious Ivy League college in May, recently passed Level I

of the CFA exam, and just landed her rst professional job as a junior portfolio manager

working with CFA charterholders for the Fortress mutual fund company She works in a group

setting comprised of a lead portfolio manager and one or more co- or junior portfolio

managers who together make the investment management decisions for a single mutual fund

Jones has observed the following behavior during the committee meetings where the portfolio

managers discuss which investments should be a part of the portfolio: analyst A always sides

with and follows the lead of analyst B, analyst C tends to have a di erent opinion from the

group view but fears being ostracized therefore he rarely voices his opinion, manager D is very

aggressive and shoots down the opinions of others if they contradict his own and also likes to

argue with people Jones is starting to wonder whether or not she made the right decision by

taking the job and has had several thoughts about the behavior at the meetings Which of the

following of her thoughts is least re ective of how nancial decisions are typically made in a

group setting?

www.ombookcentre.in

Trang 9

A) “Decisions made at this level are made by professionals with similar backgrounds,

the committee should be functioning in a more e cient and e ective manner with

B) “Their individual behavioral biases have become exacerbated in the group setting!”

C) “These people are displaying irrational behavior which is typical of group settings!”

Explanation

In a group setting individual biases can be either diminished or ampli ed with additional

biases being created Research has shown that the investment decision making process in a

group setting is notoriously poor Committees do not learn from past experience because

feedback from decisions is generally inaccurate and slow, so systematic biases are not

identi ed

The typical makeup of a committee coupled with group dynamics leads to the problems

normally seen with committees typically comprised of people with similar backgrounds thus

they approach problems in the same manner leading the group to start thinking as a single

individual, individuals can sometimes follow the beliefs of a group, and some individuals may

feel uncomfortable expressing their opinion if it di ers with others or a powerful member of

According to behavioral nance, analysts often make excuses for their inaccurate predictions

Which of the following best represents the problem with this occurrence, from a behavioral

nance view?

A) The excuses allow poor forecasters to stay in their positions when they should be

replaced

B) The excuses will prevent analysts from recognizing their own limitations.

C) Other investors depend on these forecasts, resulting in aggregate investment

losses

Explanation

www.ombookcentre.in

Trang 10

According to behavioral nance, analysts often make excuses for their inaccurate predictions.

The excuses will prevent them from recognizing their own limitations and allow them to

continue to make inaccurate forecasts Although there is an element of truth in the other

responses, they are not the central problem in this case, according to behavioral nance

The guardian is from the Bailard, Biehl, and Kaiser (BB&K) ve-way model which classi es

investors along two dimensions according to how they approach life in general The rst

dimension, con dence, identi es the level of con dence usually displayed when the

individual makes decisions Con dence level can range from con dent to anxious The

second dimension, method of action, measures the individual's approach to decision making

Depending on whether the individual is methodical in making decisions or tends to be more

spontaneous, method of action can range from careful to impetuous The ve behavioral

types identi ed by the BB&K ve-way model are the: adventurer, celebrity, individualist,

guardian, and straight arrow

The Pompian behavioral model identi es four behavioral investor types (BITs): passive

preserver, friendly follower, independent individualist, and active accumulator The Passive

Preserver and the Active Accumulator tend to make emotional decisions whereas the Friendly

Follower and Independent Individualist tend to use a more thoughtful approach to decision

Trang 11

Which of the following is least likely a way the success of the client / adviser relationship is

measured?

A) The adviser acts as the client expects.

B) Both client and adviser bene t from the relationship.

C) The adviser has been able to successfully grow their business year after year.

Explanation

The success of the typical client/adviser relationship can be measured in four areas with each

one being enhanced by incorporating behavioral nance traits:

1 The adviser understands the long-term nancial goals of the client

2 The adviser maintains a consistent approach with the client

3 The adviser acts as the client expects

4 Both client and adviser bene t from the relationship

A) it may improve the likelihood that the investor will adhere to investment policy.

B) it allows the investor to better connect the probability of goal attainment with

investment policy

C) the optimal portfolio can then be determined analytically.

Explanation

Choosing the optimal portfolio is still a matter of judgement—a tradeo between risk and

return, but the speci cation of risk is often much easier for the investor to understand Both

remaining statements are correct

www.ombookcentre.in

Trang 12

Which of the following would least likely be considered a market anomaly?

A) Underperformance of stocks with relatively high PE ratios or low book-to-market

Typically, in a bubble, the initial behavior is thought to be rational as investors trade

according to economic changes or expectations Later, investors start to doubt the

fundamental value of the underlying asset, at which point the behavior becomes irrational

Two anomalies discussed by Fama and French are associated with value and growth stocks

Value stocks have low earnings ratios, high book-to-market values, and low

price-to-dividend ratios, with growth stocks having the opposite characteristics of high PE ratios, low

book-to-market values, and high price to dividend ratios

Financial bubbles and subsequent crashes are periods of unusual positive or negative returns

caused by panic buying and selling, neither of which is based on economic fundamentals The

buying (selling) is driven by investors believing the price of the asset will continue to go up

(down) A bubble or crash is de ned as an extended period of prices that are two standard

deviations from the mean A crash can also be characterized as a fall in asset prices of 30% or

more over a period of several months, whereas bubbles usually take much longer to form

(Study Session 4, Module 9.3, LOS 9.g)

After Polly Shrum sells a stock, she avoids following it in the media She is afraid that it may

subsequently increase in price What behavioral characteristic does Shrum have as the basis for

her decision making?

Trang 13

Shrum refuses to follow a stock after she sells it because she does not want to experience the

regret of seeing it rise The behavioral characteristic used for the basis for her decision

making is the fear of regret

(Study Session 4, Module 9.3, LOS 9.g)

Analyst M routinely adjusts his previously vague forecasts to t new information that has just

been made available making his forecast look better than it actually was Analyst Q judges the

probability of her forecast being correct on how well the available data ts the outcome Which

of the following behavioral biases are M and Q displaying? M is displaying:

A) hindsight bias and Q is displaying representativeness.

B) illusion of knowledge and Q is displaying availability bias.

C) illusion of control bias and Q is displaying self-attribution bias.

Explanation

Hindsight bias is when the analyst selectively recalls details of the forecast or reshapes it in

such a way that it ts the outcome

In representativeness, an analyst judges the probability of a forecast being correct on how

well the available data represent (i.e., t) the outcome The analyst incorrectly combines two

probabilities: (1) the probability that the information ts a certain information category, and

(2) the probability that the category of information ts the conclusion

Illusion of knowledge is when the analyst thinks they are smarter than they are This, in turn,

makes them think their forecasts are more accurate than the evidence indicates The illusion

of knowledge is fueled when analysts collect a large amount of data

The illusion of control bias can lead analysts to feel they have all available data and have

reduced or eliminated all risk in the forecasting model; hence, the link to overcon dence

The availability bias is when the analyst gives undue weight to more recent, readily recalled

data Being able to quickly recall information makes the analyst more likely to " t" it with

new information and conclusions

In self-attribution bias analysts take credit for their successes and blame others or external

factors for failures Self-attribution bias is an ego defense mechanism, because analysts use it

to avoid the cognitive dissonance associated with having to admit making a mistake

www.ombookcentre.in

Trang 14

Which of the following is least likely a limitation of classifying an investor into a behavioral type?

A) The client portfolio constructed by the adviser most likely will not fall on the

e cient frontier

B) Individuals tend to act irrationally at unpredictable times because they are subject

to their own speci c psychological traits and personal circumstances In other

C) Even though two individuals may fall into the same behavioral investor type, the

individuals should not necessarily be treated the same due to their unique

Explanation

The client portfolio constructed by the adviser not falling on the e cient frontier is not a

limitation but the result of classifying an investor into a behavioral type It results in a

portfolio that is better suited to the client given their behavioral biases

Limitations of classifying investors into the various behavioral investor types include:

Individuals may simultaneously display both emotional biases and cognitive errors allthe while seeming to act rationally, making it di cult to classify the individual

according to behavioral biases

An individual might display traits of more than one behavioral investor type, making it

di cult to place the individual into a single category

As investors age, they will most likely go through behavioral changes, usually resulting

in decreased risk tolerance along with becoming more emotional about their investing

Even though two individuals may fall into the same behavioral investor type, theindividuals should not necessarily be treated the same due to their uniquecircumstances and psychological traits

Individuals tend to act irrationally at unpredictable times because they are subject totheir own speci c psychological traits and personal circumstances In other words,people don't all act irrationally (or rationally) at the same time

(Study Session 4, Module 9.1, LOS 9.a)

www.ombookcentre.in

Trang 15

Which of the following best characterizes overcon dence in expert forecasters, according to

behavioral nance? Expert forecasters are overcon dent in their forecasting ability because:

A) of the positive reinforcement they receive from the media.

B) they have access to information others do not.

C) they feel their knowledge allows them to make more accurate forecasts.

Explanation

According to behavioral nance, expert forecasters are overcon dent in their forecasting

ability because they feel their knowledge allows them to make more accurate forecasts

Because they believe their forecasts are based on skill, they blame some external factor when

the forecasts turn out incorrect Although the other responses may have some real world

validity, they are not given as a reason for overcon dence, according to behavioral nance

According to behavioral nance, which of the following best represents how investors will

diversify a portfolio for their de ned contribution pension?

A) According to their employer’s advice.

B) Using modern portfolio theory.

C) Using 1/n diversi cation.

Explanation

Investors will diversify a portfolio for their de ned contribution pension using 1/n

diversi cation If their employer o ers ten mutual funds, employees will tend to put

one-tenth of their contribution in each mutual fund

www.ombookcentre.in

Trang 16

Which of the following statements most accurately describes social proof bias? Social proof bias

is when:

A) an individual follows the beliefs of a group.

B) an individual in a group setting is perceived by the group as being socially adept

and thus a functional member of the group

C) the individuals in a group start thinking and acting as if they are a single individual.

Explanation

Social proof bias is when individuals tend to follow the beliefs of a group Group think is

when the group setting is very amiable thus leading to little or no con icting discussions

resulting in the group making decisions as if the group was a single individual

(Study Session 4, Module 9.3, LOS 9.f)

Investor X works for company A and investor Y works for company B Company A makes a

matching contribution into their employees' retirement funds in cash whereas company B

matches with company stock Which of the following are the most likely behavioral traits

exhibited by both employees?

A) Investor Y will purchase more company stock than investor X.

B) Investor X will purchase more company stock than investor Y with the nal

proportions being approximately equal in their retirement plans

C) Both investor X and Y will purchase company stock in approximately the same

proportions so the nal allocation of company stock is actually higher in investor Y’sl

Explanation

Research has shown that employees who can choose where the employer match is invested

allocate a smaller amount of their own funds to their employer's stock than when the

employer match is made with company stock In other words the employee who is receiving a

retirement match in company stock is more likely to purchase more company stock with their

own funds than an employee who receives a retirement match in cash This behavioral bias is

a type of framing because the employee may be interpreting the company's match in

company stock as implicit advice regarding the stock

www.ombookcentre.in

Trang 17

Bobby Steele, a software engineer at a local rm, has been investing for the past two years and

has been very successful He shuns professional investment advice and in fact provides advice

to his neighbors and friends He states that his investment philosophy consistently

outperforms the experts Which of the following best describes the implications of Steele's

C) Steele is likely to have low turnover in his portfolio and is likely to base stock

valuation on fundamental analysis

Explanation

Steele is an overcon dent investor As a result, he will have high turnover in his portfolio

because he will believe that he can accurately forecast the future performance of stocks He

will also make bets that are unjusti ed because he does not understand that he does not

possess all the information necessary to form unbiased projections

A) driven by fear of regret.

B) when an individual holds onto winning stocks and sells losing stocks.

C) seen in retail investment accounts.

www.ombookcentre.in

Trang 18

The disposition e ect is seen in retail brokerage accounts where winners are sold too soon

and losing stocks are held too long The disposition e ect is also thought to be driven by fear

Many de ned contribution plan participants tend to hold a large amount of assets in company

stock relative to other asset classes Which of the following characteristics of a DC plan

participant's portfolio best re ects the reason behind this tendency?

A) Familiarity.

B) Naive diversi cation.

C) Status quo bias.

Explanation

DC participants tend to hold excess stock of the company they work for due to familiarity

which is the tendency for individuals to invest in where they are most comfortable or familiar

which could be the company they work for Naive diversi cation is allocating an equal

amount of retirement savings to each investment option Note that the status quo bias refers

to a lack of action on the part of the participant

Trang 19

B) Status quo bias and nạve diversi cation also referred to as 1/n nạve

diversi cation

C) Familiarity, overcon dence, and naively extrapolating past returns.

Explanation

Two biases commonly seen in de ned contribution retirement plans are the status quo bias

and nạve diversi cation also known as 1/n nạve diversi cation When the employee is

subject to status quo bias, he leaves his initial asset allocation as is without adjusting it for

changing circumstances, even as he ages and his wealth and risk tolerance change Nạve

diversi cation, also referred to as 1/n nạve diversi cation, is allocating an equal proportion

of their retirement assets to each fund alternative The other behavioral biases are

commonly seen when an investor purchases their own company's stock

A) The committee members get along well and there is little animosity or in- ghting

between the committee members

B) The committee members are encouraged to speak out so di erent opinions are

heard

C) The committee is comprised of individuals from di erent backgrounds and where

the committee chair encourages people to voice their opinions even if it is contrary

Explanation

E ectively functioning groups would have the following features:

Be comprised of individuals with diverse backgrounds

Have members who are not afraid to express their opinions even if it di ers fromothers

Have a committee chair that encourages members to speak out even if the member'sviews are contrary to the group's views

A mutual respect for all members of the group

(Study Session 4, Module 9.3, LOS 9.f)

www.ombookcentre.in

Tiêu đề	Behavioral Finance And Investment Processes
Trường học	Kaplan
Chuyên ngành	Behavioral Finance
Thể loại	Qbank
Năm xuất bản	2019
Thành phố	N/A

Định dạng
Số trang	39
Dung lượng	1,01 MB