Section 6

Question 1

Hot Hand Fallacy

Answer 1

The hot hand fallacy is the assumption that a losing streak will continue as any trend is bound to continue.

Question 2

Why do investors hold inefficient portfolios?

Answer 2

Inertia and emotional attachment based on the endowment effect.

Question 3

Anchoring and Adjustment is what?

Answer 3

Example - Lupita made her first mutual fund investment in a technology mutual fund in 1999. She lost more than half of her investment during the market correction of 2000. Lupita has since been convinced that technology mutual funds are too risky for any part of her investment portfolio.

Answer - Lupita “anchored” her perception of technology investing to a severe market correction. She then failed to “adjust” her perception of technology investing to her current situation.

Question 4

Robert Schiller’s “volatility puzzle”

Answer 4

I. suggested stock prices move far more than they should be based on earnings and interest rate variations

II. disputed efficient market theorems

Question 5

The system responsible for basic, automatic responses is known as

Answer 5

System 1

System 1 is focused on basic automatic responses and has evolved for survival instincts, like those found in animals.

Question 6

Traditional finance and behavioral finance differ in that

Answer 6

Traditional finance ignores human nature in relation to capital markets.

Question 7

It is important for advisors to understand the concepts of behavioral finance because?

Answer 7

1. Knowledge of behavioral finance involves ethical considerations.
2. Markets tend to be inefficient, based in part on investor sentiment and momentum.
3. The decision errors of individuals have an effect on market movement.

Question 8

The unwillingness to sell losing stocks and the eagerness to lock in gains on winning stocks, known as

Answer 8

Disposition effect

Question 9

Endowment Effect

Answer 9

is the tendency to prefer what is ours, such as becoming attached to a gift of Apple’s shares, regardless of the fundamentals of the company or returns of the stock.

Question 10

Loss Aversion

Answer 10

places an excess negative value on any loss from the reference point. This means that very small losses are irrationally painful.

Question 11

Framing

Answer 11

stating a financial goal or tactic in a way that the client will view more positively and can be helpful in encouraging clients to make more sensible conservative decisions after markets rise or to help clients navigate investment losses.

Question 12

Prospect Theory

Answer 12

• Reference Dependence
• Loss Aversion
• Nonlinear Probability Weighting

I. People react emotionally to losses; very small losses are irrationally painful.

II. Loss aversion places an excess negative value on any loss from a reference point.

Question 13

Satisficing

Answer 13

Satisficing involves making the “good enough” decision or recommendation.

Question 14

Market anomalies in the context of behavioral finance

Answer 14

1. Low Volatility Anomaly
2. Value Effect
3. Small-Stock effect

Question 15

What was Fama and French Research?

Answer 15

I. There is no evidence that stock managers are able to persistently beat the market.

II. Value exchange-traded funds (ETFs) can match the performance of skilled active managers due to market inefficiencies, according to research in behavioral finance.

Question 16

Can a client take more systematic risk ?

Answer 16

An investor cannot take on more systematic risk.

Question 17

Can you select investments with betas greater than or to increase their expected return?

Answer 17

No, all betas are greater than 0, a beta of greater than 1 would mean riskier than the market.