Chapter 4 TF

Question 1

Risk-averse investors generally must sacrifice some expected return in order to reduce the variation in possible outcomes from an investment decision.

Answer 1

True

Question 2

In the field of finance, risk seeking refers to a preference for uncertain outcomes over certain outcomes.

Answer 2

True

Question 3

Research has shown that for most people the extent of risk seeking that occurs when a choice is between losses is much lower than the extent of risk avoiding that occurs when a choice is between gains

Answer 3

False. The research on this subject, such as that done by Tversky and Kahneman as cited in the textbook, suggests the opposite result. Given a choice between two gains, most people are risk averters. Given a choice between two losses, however, most people are risk seekers.

Question 4

In defining risk, most people intuitively focus on uncertainty about negative outcomes or losses rather than uncertainty about positive outcomes or gains.

Answer 4

True

Question 5

Research has consistently demonstrated that the objective riskiness of a situation and people’s perception of that riskiness are identical

Answer 5

False. Research results suggest that perceived riskiness often differs from objective riskiness, with perceived riskiness frequently affected by people’s experience, knowledge, psychological inclinations, and other factors

Question 6

In making decisions involving risk, most people violate rationality to some degree.

Answer 6

True

Question 7

Research comparing how people react to a reduction in a risk versus the complete elimination of the risk suggests that most people place a disproportionately high value on risk elimination.

Answer 7

True

Question 8

The “choice shift” phenomenon found in the study of group dynamics in risk-taking situations refers to the fact that group decisions tend to favor less risky action than individual decisions.

Answer 8

False. Group dynamics tend to lead to more risky decisions or actions than decisions favored by individual members of the group when they are polled separately before the group discussion

Question 9

Research suggests that people’s mental accounting for gains and losses resulting from a decision places more importance on a gain of a particular dollar amount than on a loss of the same amount.

Answer 9

False. Research on this point suggests that the happiness and importance associated with a gain of a given amount are less than the unhappiness and importance associated with a loss of the same amount

Question 10

Knowing that a client is a risk taker in a certain physical activity (for example, skydiving) provides strong evidence that the client will also be a risk taker when it comes to financial decisions.

Answer 10

False. One should be very careful in inferring a high level of risk tolerance in financial matters from a client’s high level of risk tolerance in physical activities.

Question 11

Risk takers typically like ambiguity rather than structure.

Answer 11

True

Question 12

Research results clearly point out that wealthy individuals have higher absolute financial risk tolerances

Answer 12

True

Question 13

Most research suggests that single individuals who have no dependents are more risk tolerant than married persons with dependents.

Answer 13

True

Question 14

A high level of risk tolerance is a major characteristic that differentiates entrepreneurs from nonentrepreneurs

Answer 14

False. Research does not support the common sense assumption that people who are entrepreneurs are also high risk takers.

Question 15

For most investors, the phrases “emerging growth” and “tax free” suggest low risk.

Answer 15

False. According to research, “tax free” suggests low risk to most clients, whereas “emerging growth” suggests high risk

Question 16

In order to assess a client’s risk-taking propensity with reasonable accuracy, use of more than one assessment technique is normally necessary.

Answer 16

True

Question 17

A weakness of most currently available questionnaires for measuring clients’ risk tolerance is that the questionnaires do not have norms.

Answer 17

True

Question 18

One of the advantages of measuring clients’ risk tolerances by asking them what financial products they prefer as investments is that clients are usually thoroughly familiar with the risk return characteristics of most types of available investment products.

Answer 18

False. Surveys reveal that members of the general public, including the wealthy, are very often ignorant about the risk return potential of the various types of financial products.

Question 19

Attitudes about risk frequently fail to predict actual behavior because too many risk-tolerance questions are asked.

Answer 19

False. In order to predict actual behavior, one usually has to consider answers to a fairly large number of attitude questions. Research shows that when attitudes fail to predict behavior, it is because not enough attitude questions were asked.

Question 20

Clients are more likely to overstate than to understate their own risk tolerance

Answer 20

True

Question 21

The way a question about a risk-taking situation is “framed” can have an important effect on the willingness of respondents to take on the risk.

Answer 21

True