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

Brophy and Carr know nothing about investing, but the recent past returns of the funds lookpretty high, and Swank's stock has done very well in recent years.. The rm was near bankruptcy,

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Question #1 of 54

Mike McLaughlin is an economist who makes quarterly forecasts for the state of the economy

and interest rates Last quarter, the economy did not grow as fast as McLaughlin predicted

McLaughlin explains that his forecast was inaccurate by stating "This change in the economy

was due to a real estate market that slowed faster than many forecasters, including myself,

expected If it weren't for the real estate market, my projection for GDP would have been

accurate." Which of the following is the best interpretation of McLaughlin's statement, from a

behavioral nance view? McLaughlin is using:

A) an “if-only” defense for his inaccurate forecasts and his recognition of it will sharpen his

abilities

B) hindsight bias as a defense for his inaccurate forecasts and this will prevent him from

accurately evaluating his own abilities

C) a self attribution defense for his inaccurate forecasts and this will prevent him from

accurately evaluating his own abilities

Which of the following would least likely be viewed as rational behavior during a market

bubble?

A) Investors believe the price of a stock will continue to go up therefore they buy more.

B) A real estate portfolio manager has no suitable alternative investments to switch to.

C) The investor knows she is in a bubble but she doesn’t know where the peak is.

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B) overcon dence.

C) the disposition e ect.

When an investor extrapolates past data from a small sample size into a forecast this is most

likely indicative of:

A) the recency bias.

B) fear of regret.

C) hindsight bias.

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

A) Bubbles and crashes.

B) Underperformance of stocks with relatively high PE ratios or low book-to-market values.

C) The stock market continues to climb as investors are trading according to economic

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

C) the optimal portfolio can then be determined analytically.

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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

investment style?

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

on fundamental analysis

B) Steele is likely to have low turnover in his portfolio and is likely to make unjusti ed bets.

C) Steele is likely to have high turnover in his portfolio and is likely to make unjusti ed

bets

Joseph Brophy and Pamela Carr work in the collections department of Swank's, an upscale

department store in downtown Cleveland Swank's is a publicly traded company with more

than 400 locations nationwide, and is also rated by national publications as one of the best

places to work Brophy and Carr like their jobs, and like the company for which they work.

Swank's recently switched from a de ned-bene t plan to a de ned-contribution plan, and

employees with vested pension assets were given lump sums, with the option of investing that

money in the new plan Both Brophy and Carr have worked for Swank's for more than 10 years,

and as such receive sizable payments, which they intend to move into the new plan.

On the day enrollment forms arrive at the Cleveland o ce, Brophy and Carr have lunch

together to discuss the new pension plan The investment packet contains a short newsletter

that provides historical performance data on the investment options Here are the choices:

An S&P 500 Index fund

A large-cap value fund

A small-cap value fund

A small-cap growth fund

A mid-cap blend fund

An aggressive-growth stock fund

A foreign-stock fund

A long-term bond fund

A short-term bond fund

Swank's stock, available at a 5% discount to market price

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Brophy and Carr know nothing about investing, but the recent past returns of the funds look

pretty high, and Swank's stock has done very well in recent years Carr, who is 15 years younger

than Brophy, likes the returns on some of the stock funds and on Swank's stock Brophy is ve

years away from retirement and feels he's too old to learn about nancial management During

his discussion with Carr, he remembers an article he read in Forbes years ago He can recall

nothing about the article except that the writer said diversi cation was a good idea Carr

responds by warning that you have to make bets on a winner if you expect to earn good

returns.

Brophy assumes that Swank's wouldn't recommend any funds unless they were good, and in an

e ort to diversify, puts 10% of his money into each option.

Carr wants to earn the biggest returns possible, so she invests 50% of her money in Swank's

stock and split the remaining cash between the small-cap growth fund and the

aggressive-growth fund.

Twelve months after the start of the new pension plan, all Swank's employees have the

opportunity to change their investment elections Brophy sees that his portfolio is up roughly in

line with the S&P 500 Index, so he leaves his elections intact Carr notes that Swank's stock has

fallen 25%, and the portfolio was roughly at with year-earlier levels Grumbling, she changes

her allocation so the portion currently in Swank's stock is divided between the available bond

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C) Pyramiding.

Brophy's initial investment choices show he has fallen prey to which of the following traps?

A) Familiarity.

B) Status quo bias.

C) Naive diversi cation.

Swank's wants to improve its de ned-contribution pension plan Which of the following actions

will be least helpful to employees?

A) Provide detailed nancial and performance data on the company stock.

B) Allow the employees to change their allocations more than once a year.

C) Increase the number of fund options.

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Neither Brophy nor Carr made optimal investment decisions In the wake of the portfolio

rebalancing, which of the following statements best re ect the situation of which employee?

Has allocated portfolio

best-Exhibits herding behavior

Terry Shiver and Mary Trickett are portfolio managers for High End Investment Managers High

End provides investment advice to wealthy individuals As part of their annual review of their

client portfolios, they review the appropriateness of their client portfolios given their clients'

return objective, risk tolerance, time horizon, liquidity constraints, tax situation, regulatory

situation, and unique circumstances

Their boss, Jill Castillo, is concerned that Shiver and Trickett allow the clients' behavioral biases

to enter into the asset allocation decision She has asked them to review their notes from

meetings with clients and examine the clients' statement for potential biases The information

below is excerpts from their notes, along with the client's name

Tom Heggins: "In the past ve years, I have consistently outperformed the market averages in

my stock portfolio It really does not take a genius to beat a market average, but I am proud to

say that I have beaten the market averages by at least 2 percent each year and have not once

lost money I would continue managing my portfolio myself because I know I could keep

beating the averages, but with a new baby on the way and a promotion to Senior Vice President

at my technology rm, I just don't have the time."

Joanne McHale: "The last three quarters were bad for my portfolio I have lost about a third of

my portfolio's value, primarily because I invested heavily in two aggressive growth mutual

funds whose managers had o quarters I need to get back that one-third of my portfolio's

value because I am only fteen years away from retirement and I don't have a de ned-bene t

pension plan Because of this, I am directing Mary Trickett to invest my savings in technology

mutual funds Their potential return is much higher and I believe I can make back that loss with

an investment in them."

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Jack Sims: "I enjoy bird watching and hiking outdoors I am an avid environmental advocate and

will only invest in rms that share my concern for the environment My latest investment was in

Washington Materials Washington was recently featured in an environmental magazine for

their outstanding dedication to environmental protection The CEO of Washington was also

featured on the cover of Fortune magazine He has turned the rm around in the three years

he has been there The rm was near bankruptcy, but now Washington is the leader in its niche

market, which is waterproof fabric for outdoor clothing and equipment."

Which of the following best describes Tom Heggins's behavioral characteristic in investment

decisions?

A) Tom is overcon dent.

B) Tom uses anchoring.

C) Tom uses frame dependence.

Which of the following best describes the potential problem with Heggins's investment strategy

in regards to certainty overcon dence?

A) He will overestimate the risk of his portfolio and overestimate the impact of an event on

Which of the following most likely explains Tom Heggins's behavior in investment decisions?

A) Tom is su ering from an illusion of knowledge in assessing his skills.

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B) Tom uses anchoring to assess his skills.

C) Tom uses the ceteris-paribus heuristic to assess his skills.

Which of the following best describes Joanne McHale's behavioral characteristic in investment

decisions?

A) Joanne’s regret too heavily in uences her investment decisions.

B) Joanne uses the ceteris-paribus heuristic.

C) Joanne is loss averse.

Which of the following least accurately describes Jack Sims's behavioral characteristic in

investment decisions?

A) Jack is using the representativeness bias.

B) Jack would be classi ed as an Active Accumulator personality type.

C) Jack is using the availability bias.

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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 control bias and Q is displaying self-attribution bias.

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

When an investor stays with the default investor option and default contribution rate in a

company retirement plan this is an example of:

A) conditional nạve diversi cation.

B) status quo bias.

C) familiarity.

All of the following are prescribed methods of measuring the success of the client / adviser

relationship EXCEPT the:

A) client is satis ed with the return they are getting from their portfolio.

B) adviser maintains a consistent approach with the client.

C) adviser understands the long-term nancial goals of the client.

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

measured?

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

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

C) The adviser acts as the client expects.

According to behavioral nance, which of the following best describes the components of

individual investors' portfolios?

A) Their portfolios will be over concentrated in their employer’s stock and risky securities.

B) Their portfolios will be over concentrated in risky securities.

C) Their portfolios will be over concentrated in their employer’s stock and domestic

securities

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

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

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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 X will purchase more company stock than investor Y with the nal proportions

being approximately equal in their retirement plans

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

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

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 feel their knowledge allows them to make more accurate forecasts.

C) they have access to information others do not.

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

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A) 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

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 words,

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 according

b h i l bi

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

C) 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

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

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

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

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

d il d

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

with using a large enough sample size and Bayes’ formula

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Jack Melby places his investments into di erent "mental accounts" with each investment being

tied to accomplishing a di erent goal All the investments together comprise a pyramid where

the most conservative investments are on the bottom layer to meet his most immediate and

important goals Riskier investments are represented higher up in the pyramid and used to

meet less immediate goals This behavioral trait is:

A) not the most e cient from a traditional nance perspective but acceptable because the

portfolio tends to be fairly well diversi ed and if constructed properly from a behavioral

B) called “mental accounting” and is not thought to be an acceptable way for investors to

allocate their assets

C) perceived as being ine cient and the investment adviser should try to persuade the

investor to allocate their assets to resemble an allocation based on traditional nanceh

Which of the following are uses of classifying investors into various types? Classifying investors

into behavioral types:

A) allows the advisor to have a better understanding of how to approach their client when

educating them on traditional nance concepts

B) gives the adviser the tools to be able to explain to the client why their portfolio should

resemble the “rational portfolio” based on traditional nance concepts

C) helps the advisor understand their client resulting in better overall investment decisions

being made that are closer to the e cient frontier

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