Psychology of Financial Planning (7%)

Question 1

Prospect theory

Answer 1

is when a person is more afraid of losses than they are satisfied by gains.

Even though Jean Paul made a great deal of money trading options he is afraid to touch them after losing money in 2008.

Question 2

Anchoring

Answer 2

has to do with over relying on the first piece of information that we come across

Question 3

authority bias

Answer 3

may trust your judgment due to authority bias

Question 4

Home bias

Answer 4

is the tendency for investors to overweight their portfolio in securities based in the country or region in which they live.

Question 5

Herd Mentality

Answer 5

wanting to get in on the ground floor with his coworkers is an example of

Question 6

Bandwagon Effect

Answer 6

desire to do something because others are doing it as well.

Question 7

action bias

Answer 7

desire to purchase cryptocurrency immediately and not wait for the report is an example.
There is no downside to waiting as the price is frozen until the report comes out, however Jean Paul still wants to take action and purchase the coin immediately.

Question 8

gambler’s fallacy

Answer 8

when someone believes that the probability of an event is different after a series of outcomes than it is after a single outcome.

For example, someone with the gambler’s fallacy might believe that tails is more likely to occur after a series of heads when flipping a coin

Question 9

halo effect

Answer 9

is a type of cognitive bias in which the overall impression of a person influences how others feel and think about a person’s specific traits. For example, “He is nice!” affects the perception of other particular characteristics (“He is also smart!”

Question 10

Mental accounting

Answer 10

is a behavioral economics concept that describes how people categorize, manage, and spend money. It’s based on the idea that people value money differently depending on how they earned it, how they intend to use it, and their subjective value of it.

Spending windfalls
People are more likely to spend money they consider a “windfall” than regular income, and they may spend it on luxury goods instead of essentials.

Disassociating portfolios
Investors may separate safe portfolios from speculative portfolios so that negative returns from the latter don’t affect positive returns from the former

Question 11

Naïve realism

Answer 11

is a cognitive bias that describes the tendency to believe that our perception of the world is objective and accurate

Question 12

recency bias.

Answer 12

relying on recent events and using them to determine his investment strategy. He has decided to invest in the most recent system he was working on despite having worked with numerous systems before hand. This, coupled with the reliance on the announcement as the main impetus of buying the stock all point to

Question 13

Overconfidence bias

Answer 13

is the tendency to overestimate our knowledge and abilities in a certain area. As people often possess incorrect ideas about their performance, behavior, or characteristics, their estimations of risk and success often deviate from reality.

Question 14

Confirmation bias

Answer 14

the tendency of people to favor information that confirms or strengthens their beliefs or values and is difficult to dislodge once affirmed

Question 15

The familiarity bias

Answer 15

is a phenomenon in which people tend to prefer familiar options over unfamiliar ones, even when the unfamiliar options may be better.

Question 16

The Ellsberg paradox

Answer 16

is a behavioral economics and decision theory phenomenon that describes how people tend to avoid ambiguity and uncertainty when making decisions.
In the experiment, participants choose an urn and then bet on a color to win money. The winning probability for both urns is 50%, but most participants prefer to avoid the urn with the unknown odds. This preference is called ambiguity aversion

Question 17

The endowment effect

Answer 17

describes how people tend to value items that they own more highly than they would if they did not belong to them. This means that sellers often try to charge more for an item than it would cost elsewhere.

Question 18

The projection bias

Answer 18

is a self-forecasting error where we overestimate how much our future selves will share the same beliefs, values and behaviors as our current selves, causing us to make short-sighted decisions.