Lesson 6

Question 1

Devan sees that a specific fund manager has a long-term track record of success. The fund manager
cannot seem to make a mistake. Devan chooses to invest in the fund thinking the manager’s luck will
continue. What heuristic or bias is affecting his decision?

A. Home bias
B. Hot hand fallacy
C. Overconfidence bias
D. Confirmation bias

Answer 1

B. Hot hand fallacy

Question 2

An advisor begins a conversation about retirement age by suggesting a more realistic older age rather
than beginning by asking the client their desired age. This technique takes advantage of:

A. Anchoring
B. The endowment effect
C. Satisficing
D. Hedonic adaptation

Answer 2

A. Anchoring

Question 3

An investment company operates a large research division that identifies attractive stocks using
publicly available data. This is consistent with:

A. strong form market efficiency
B. semi-strong form market efficiency
C. weak form market efficiency
D. the mutual fund theorem

Answer 3

C. weak form market efficiency

Question 4

According to CAPM, which of the following should predict future stock returns?

A. size
B. beta
C. value
D. momentum

Answer 4

B. beta

Question 5

Which of the following is a characteristic of System 2 in the Two Systems Theory?

A. Faster responses
B. Environmental or cultural factors
C. A more deliberate response
D. Emotional responses

Answer 5

C. A more deliberate response

Question 6

You suggest an investor sell shares of a large position in a single technology stock, but the investor
disagrees and explains that they have heard positive information about the firm’s future prospects. The
investor may be experiencing:

A. Hindsight bias
B. Confirmation bias
C. Overconfidence bias
D. Home bias

Answer 6

B. Confirmation bias

Question 7

A client has quickly doubled their money on a stock. Their advisor feels that this is a good opportunity
to recommend transferring the gains from the stock sale into a needed risk product they otherwise
might not consider. This technique takes advantage of:

A. disposition effect
B. the endowment effect
C. the house money effect
D. hedonic adaptation

Answer 7

C. the house money effect

Question 8

The process of framing various client accounts based on time horizon is known as:

A. risk aversion
B. the endowment effect
C. house-money-segmentation
D. bucketing

Answer 8

D. bucketing

Question 9

Jenny has inherited a portfolio of stocks from her father. Although she is not familiar with some of the
names, she decides to keep the portfolio intact. This decision is an example of which bias in
behavioral finance?

A. Availability
B. Anchoring
C. Bounded rationality
D. Status Quo

Answer 9

D. Status Quo

Question 10

A fundamental assumption of neoclassical economic theory is:

A. investor should seek to maximize expected portfolio return
B. skilled investors can outperform the market
C. stocks are more appropriate for long-term investments
D. investors behave rationally to maximize their utility

Answer 10

D. investors behave rationally to maximize their utility

Question 11

Audra sees that a specific fund manager has a recent track record of success. The fund manager
cannot seem to make a mistake. Audra chooses to invest in the fund. Which heuristic or bias is affecting
her decision?

A. Availability
B. Overconfidence
C. Hot hand fallacy
D. Sunk cost

Answer 11

C. Hot hand fallacy

Question 12

John believes he is a great stock picker and has a lot of confidence in his employer’s prospects, so he
has allocated 95% of his portfolio to his company’s stock. This is an example of which of the following
heuristics?

A. Diversification bias; endowment effect
B. Confirmation bias; sentiment bias
C. Overconfidence; illusion of control
D. Endowment effect; stockholding puzzle

Answer 12

C. Overconfidence; illusion of control

Question 13

A client suggests that she can be perfectly happy spending 30% less in retirement. You question the
client’s assumption based on:

A. Framing
B. The endowment effect
C. Loss aversion
D. Hedonic adaptation

Answer 13

D. Hedonic adaptation

Question 14

Violations of economic theory in actual human behavior have been identified through:

A. Descriptive analyses and experiments
B. Prescriptive modeling
C. The 3-factor model
D. Modern portfolio theory

Answer 14

A. Descriptive analyses and experiments

Question 15

Ella saw that the market had dropped 500 points during the day and that her shares of Mobil had
fallen by 12%. She called her broker and said she wanted to sell all her shares as soon as the market
opens the following day. This behavior is rooted in:

A. The emotional System 1 in the Two Systems Theory
B. The rational System 2 in the Two Systems Theory
C. Her risk seeking personality
D. The disposition effect

Answer 15

A. The emotional System 1 in the Two Systems Theory

Question 16

Joseph is thrilled with his extraordinary gains in Amazon stock, so he decides to lock in his profit and
sell some of his Amazon stock and hold on to his GE shares in hopes they will eventually rise above
the price he originally paid. This behavior is consistent with:

A. the disposition effect
B. the endowment effect
C. decreasing marginal utility
D. bucketing

Answer 16

A. the disposition effect

Question 17

If an analyst notices a pattern of trends in historical stock prices and invests accordingly, the efficient
market hypothesis would suggest this is an example of:

A. a short-term pricing anomaly in the market which will eventually vanish
B. the efficient market hypothesis enabling informational outperformance
C. superior research leading to superior returns
D. the Mutual Fund Theorem

Answer 17

A. a short-term pricing anomaly in the market which will eventually vanish

Question 18

An understanding of Prospect Theory can be useful to a financial planner in helping to understand
and prepare for the client’s:

A. negative emotional response to a loss
B. overconfidence about predicting gains and avoiding losses
C. greater emotional response to gains than losses
D. unemotional processing of a loss in the account

Answer 18

A. negative emotional response to a loss

Question 19

When advising a client on a portfolio’s performance, an advisor should discuss Beta in relationship
to:

I. A stock’s absolute volatility.

II. The degree to which a stock’s price moves relative to the market.

Answer 19

B. II only

Question 20

Illusion of Control bias:

I. Encourages investors to buy only stocks that have lower risk

II. Causes investors to embrace divergence of opinion in the true value of a
company

Answer 20

D. Neither I nor II

Question 21

Each of the following is representative of hindsight bias EXCEPT:

A. Sara’s belief that market returns were higher in the decades of the 1950’s and 1960’s.
B. Since her portfolio manager correctly predicted overall stock market behavior last five years,
Janice has forgotten her initial skepticism about his abilities.
C. When speaking to his friends, John proudly points out that he knew the market was overvalued in
2008 and reduced his equity holdings at the start of January, 2008.
D. As a realtor, Harry says he knew the mortgage market was in trouble and didn’t invest in any
mortgage backed securities from 2007-2009.

Answer 21

A. Sara’s belief that market returns were higher in the decades of the 1950’s and 1960’s.

Question 22

Each of the following comments demonstrates concepts of behavioral finance EXCEPT:

A. Individuals have a general tendency to seek out information that confirms their unusual decision making
abilities.
B. Despite their biases, investors tend to outperform a market portfolio.
C. Laura and Ivan Jones have told their financial advisor that they would prefer to limit their equity
portfolio to US stocks.
D. “I will never sell the General Motors securities that I inherited from Papa”, said the client.

Answer 22

B. Despite their biases, investors tend to outperform a market portfolio.