Behavioral Finance

Question 1

Financial Counseling - Cognitive-Behavioral Approach

Answer 1

This approach believes that a client’s attitudes, beliefs, and values influence the client’s behavior and that tries to replace negative beliefs with positive attitudes that should result in better financial results

Question 2

Financial Counseling - Economic and Resource Approach

Answer 2

Focuses on obtaining and analyzing quantitative data, such as cash flow, assets, and debt

Question 3

Financial Counseling - Classical Economics Approach

Answer 3

Planners attempt to achieve better financial outcomes by increasing financial resources or reducing expenditures

Question 4

Financial Counseling - Strategic Management Approach

Answer 4

Client’s goals and values drive the client-planner relationship and the planner serves as a consultant

Question 5

Illusion of Control Bias (C)

Answer 5

Exists when market participants think they can influence outcomes when they cannot

Question 6

Conservatism Bias (C)

Answer 6

Occurs when clients initially assume a rational view but fail to change that view as new information becomes available. They overweigh the initial probabilities and do not adjust for new information.

Question 7

Hindsight Bias (C)

Answer 7

A selective memory of past events, actions, or what was knowable in the past. Clients tend to remember their correct views and forget the errors.

Question 8

Confirmation Bias (C)

Answer 8

Occurs when market participants look for new information to support an existing view. Only bring up information favorable to the holding.

Question 9

Representativeness (C)

Answer 9

Based on a belief that the past will persist and, as a result, new information is classified on previous experiences.

Base Rate Neglect: where the base rate (probability) of the initial classification is not adequately considered. Classification is presumed to be 100% correct.

Sample-Size Neglect: makes the initial classification based on an overly small and potentially unrealistic sample of data.

Question 10

Mental Accounting (C)

Answer 10

Money jar mentality, involves the tendency of individuals to put their money into separate accounts based on the function of these accounts. Keeping money in a vacation bucket when you owe considerable debt.

Question 11

Self-Attribution Bias (C)

Answer 11

an ego defense mechanism that occurs to avoid the cognitive dissonance associated with having to admit you made a mistake

Question 12

Anchoring (C)

Answer 12

Irrational decisions based on information that should have no influence on the decisions at hand. Anchoring is especially risky when people know little about the product being purchased, the service being delivered, or the investment being made.

Question 13

Adjustment (C)

Answer 13

Involves clients clinging on to an initial estimate and not adjusting for new information

Question 14

Outcome Bias (C)

Answer 14

Tendency for individuals to take a course of action based on the outcomes of prior events. An investor may choose a particular stock because that stock had superior performance over the last three years.

Question 15

Framing Bias (C)

Answer 15

Asserts that people are given a frame of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make decisions.

Question 16

Recency Bias (C)

Answer 16

Recent information is given more importance because it is most vividly remembered. Also called “Availability Bias” because it is based on data that are readily available, including small data samples or data that do not provide a complete picture.

Question 17

Herding (C)

Answer 17

When investors trade in the same direction or in the same securities, and possibly, trade contrary to the information they have available.

Question 18

Prospect Theory (E)

Answer 18

Clients fearing losses much more than valuing gains. Often, they will choose the smaller of two potential gains if it avoids a sure loss.

Question 19

Loss Aversion Theory (E)

Answer 19

Involves clients valuing gains and losses differently and, as a result, will make decisions based on perceived gains rather than perceived losses.

Question 20

Overconfidence (E)

Answer 20

Investors exhibiting overconfidence believe they can control random events merely by acquiring more knowledge and consider their abilities to be better than they are. They take credit for any financial decisions that have positive results. Any negative outcomes are attributed to external sources.

Question 21

Self-Control Bias (E)

Answer 21

Occurs when individuals lack self-discipline and favor immediate gratification over long-term goals.

Question 22

Status Quo Bias (E)

Answer 22

Occurs when comfort with an existing situation leads to an unwillingness to make changes.

Question 23

Endowment Bias (E)

Answer 23

Occurs when an asset is deemed special and more valuable simply because it is already owned

Question 24

Regret-Aversion Bias (E)

Answer 24

Occurs when market participants do nothing out of excess fear that actions could be wrong. Their sense of regret and pain is stronger for acts of doing something.