s3 1 answers

Schweser Printable Answers - S3-1

Test ID#: 12

Question 1 - #138275

All of the following are behavioral investor types identified by Pompian EXCEPT the:

Your answer: B was incorrect. The correct answer was A) guardian.

The guardian is from the Bailard, Biehl, and Kaiser (BB&K) five-way model which classifies investors along two dimensions according to how they approach life in general. The first dimension, confidence, identifies the level of confidence usually displayed when the individual makes decisions. Confidence level can range from confident to anxious. The second dimension, method of action, measures the individual抯 approach to decision making. Depending on whether the individual is methodical in making decisions or tends to be more spontaneous, method of action can range from careful to impetuous. The five behavioral types identified by the BB&K five-way model are the: adventurer, celebrity, individualist, guardian, and straight arrow.

The Pompian behavioral model identifies four behavioral investor types (BITs): passive preserver, friendly follower, independent individualist, and active accumulator. The Passive Preserver and the Active Accumulator tend to make emotional decisions whereas the Friendly Follower and Independent Individualist tend to use a more thoughtful approach to decision making.

This question tested from Session 3, Reading 9, LOS a.


Jean Stall, CFA, has just completed the yearly review for one of her clients Jeff Schaller. During the review she went over the original questionnaire he filled out to make sure the current portfolio has not drifted too far from the original asset allocation as determined by the questionnaire. The questionnaire was well designed to quantitatively determine Schaller抯 level of risk aversion. One of Schaller抯 statements in the questionnaire was that he was comfortable investing in stocks but did not want to lose any money in the stock market. As a result Stall took a portion of his non-retirement money and put it in an indexed annuity which is a long term investment guaranteed not to lose any money but will participate in any market gains. Which of the following isNOT an error that Stall committed?

Your answer: B was incorrect. The correct answer was A) Stall met with Schaller on a yearly basis.

Stall made several errors regarding the questionnaire and subsequent meeting:

1. The questionnaire should be re-administered during the yearly review to make sure any changes in the client抯 circumstances are captured.

2. The questionnaire should be able to identify behavioral biases displayed by the client which there is no mention of this occurring.

3. Stall interpreted Schaller抯 statement about not wanting to lose any money too literally resulting in an inappropriate product, the annuity which is a long term retirement product, being used for non-

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A) guardian.

B) active accumulator.

C) friendly follower.

A) Stall met with Schaller on a yearly basis.

B) There is no mention that behavioral traits were addressed in the questionnaire.

C)Stall took Schaller抯 comment too literally and may have placed him in a potentially inapproan inappropriate product with the indexed annuity.

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retirement savings. She should have inquired further into his statement to see if he really meant not to lose any money in an investment or if he is just overly risk averse.

This question tested from Session 3, Reading 9, LOS b.

Question 3 - #91532

After Polly Shrum sells a stock, she avoids following it in the media. She is afraid that it may subsequently increase in price. What behavioral characteristic does Shrum have as the basis for her decision making?

Your answer: A was incorrect. The correct answer was C) Fear of regret.

Shrum refuses to follow a stock after she sells it because she does not want to experience the regret of seeing it rise. The behavioral characteristic used for the basis for her decision making is the fear of regret.

This question tested from Session 3, Reading 9, LOS f.


The inability of technical trading rules to consistently provide excess returns is most likely used as proof that a market is at least:

Your answer: C was correct!

In a weakly efficient market, prices incorporate all past price and volume information, so technical trading rules will fail to consistently produce excess returns. Although by definition a market that is semi-strong form or strong-form efficient will also be weak-form efficient, we cannot say that the inability to generate excess returns using technical data would in itself indicate semi- or strong-form efficiency

This question tested from Session 3, Reading 7, LOS d.


Which of the following statements most accurately describes social proof bias? Social proof bias is when:


Social proof bias is when individuals tend to follow the beliefs of a group. Group think is when the group setting is very amiable thus leading to little or no conflicting discussions resulting in the group making decisions as if the group was a single individual.

A) Representativeness.

B) Anchoring.

C) Fear of regret.

A) semi-strong form efficient.

B) strong-form efficient.

C) weak-form efficient.

A) the individuals in a group start thinking and acting as if they are a single individual.

B) an individual in a group setting is perceived by the group as being socially adept and thus a functional member of the group.

C) an individual follows the beliefs of a group.



This question tested from Session 3, Reading 9, LOS e.

Question 6 - #92736

Which of the following best characterizes overconfidence in expert forecasters, according to behavioral finance? Expert forecasters are overconfident in their forecasting ability because:

Your answer: B was correct!

According to behavioral finance, expert forecasters are overconfident in their forecasting ability because they feel their knowledge allows them to make more accurate forecasts. Because they believe their forecasts are based on skill, they blame some external factor when the forecasts turn out incorrect. Although the other responses may have some real world validity, they are not given as a reason for overconfidence, according to behavioral finance.



Assuming a stock will perform well in the future because the company just released a good earnings report usually results in:

Your answer: A was incorrect. The correct answer was C) the stock becoming overpriced and underperforming.

Representativeness can lead investors to make incorrect projections based upon stereotypes. Since investors� perceptions are based upon current or historical information rather than unbiased expectations, stocks can be temporarily mispriced. An example is assuming a stock will perform well in the future because the firm just unexpectedly announced good earnings over the last period. Assuming the good announcement implies good future performance (a winner), investors buy the stock and push its price up. Likewise, a bad earnings announcement (a loser) may be met with selling pressure, which drives the price down. The result is that overpriced 搘inners� will tend to underperform and underpriced 搇osers� will tend to outperform, as their prices return to their intrinsic values.



What kind of behavioral bias is an investor most likely displaying when they tend to hold on to their earlier beliefs and fail to fully incorporate new information about a stock into their forecast?

Your answer: A was incorrect. The correct answer was C) Conservatism bias.

A) they have access to information others do not.

B) they feel their knowledge allows them to make more accurate forecasts.

C) of the positive reinforcement they receive from the media.

A) the stock becoming a 搘inner� and outperforming.

B) no change in value since in an efficient market the intrinsic value of the stock is already reflected in its price.

C) the stock becoming overpriced and underperforming.

A) Anchoring and adjustment bias.

B) Hindsight bias.

C) Conservatism bias.



In the conservatism bias individuals unconsciously place more emphasis on the information they used to form their original forecast than on new information. They have difficultly pulling away from an original forecast as they subconsciously place less value on new information. In anchoring and adjustment individuals are anchored to a value, such as an expected price or other forecast, as if it has a gravitational pull. Unlike the conservatism bias that has similar effects but is based on how investors relate 搉ew� information to 搊ld� information, anchoring is based on a target number; once individuals have these targets in their minds, they seem to be unduly affected by them. Hindsight bias is when individuals perceive outcomes as reasonable and expected. It抯 like saying, 揟his is what happened, and this is why it happened.� Their explanation is biased by the fact that the outcome actually did occur; their explanation is not a prediction, so it抯 difficult to argue with.

This question tested from Session 3, Reading 8, LOS c.


Which of the following statements would most likely be classified as a cognitive error? The investor:

Your answer: C was incorrect. The correct answer was A) has a tendency to place information into categories.

This describes the cognitive error of "representativeness bias" where investors classify information into the most appropriate subjective category based on "if-then" heuristics. The other two answer choices describe "loss aversion" and "regret aversion."



Tom Roberts loves to read about stocks. He subscribes to the Los Angeles Times, the New York Times, and Smart Money Magazine. He respects the various publications but places more emphasis on Smart Money magazine because it specializes in investment issues. What behavioral characteristic does Roberts have as the basis for his decision making?


Roberts uses framing as the basis for his decision making. He places more weight on the financial publication just because it specializes in investments without evaluating the investment advice on its own merits.


Question 11 - #138265

Which of the following statements best describes the availability bias? An investor:

A) has a tendency to place information into categories.

B) tends to take more risk rather than sell a stock at a loss.

C) acts defensively when asked why he made a poor investment decision.

A) Anchoring.

B) Framing.

C) Representativeness.

A) only notices information that agrees with their perceptions or beliefs.

B) associates new information with an easily recalled past event.

C) bases a decision on how the information is presented.




In the availability bias individuals estimate future probabilities by how easily they recall a past event. An easily recalled event is more quickly associated with (fit to) new information. The problem is worsened by the fact that individuals� memories can be incomplete or biased. The confirmation bias is when individuals tend to notice only information that agrees with their perceptions or beliefs. They look for confirming evidence while discounting or even ignoring evidence that contradicts their beliefs or their perceptions. In the framing bias individuals view information differently depending on the way it is presented and received.



Martina Blackwood has not been doing well with her investments. She consults Ben Haifen, CFA, for some advice. Which of Haifen's following statements indicates that Blackwood is using heuristics?

Your answer: B was incorrect. The correct answer was C) Blackwood's most valuable lessons were learned through her own mistakes.

Blackwood developed her investment style through trial and error, learning from her own mistakes called heuristics. The other statements could be true of many types of investors who are not bound by heuristic-driven bias.


Question 13 - #138267

Which of the following most closely defines base rate neglect?

Your answer: B was incorrect. The correct answer was A) A type of representativeness bias in which the probability of the categorization is not adequately considered.

When the investor exhibits base rate neglect, he does not (neglects to) consider the probability that the information does indeed fit the category into which it has been placed and places too little weight on the base rate. Conservatism can also be explained in terms of Bayesian statistics where the investor forms probabilities or base rates. With the receipt of new information, the rational investor updates those probabilities to reflect the new information. When the analyst is subject to conservatism, however, he places too much weight on the base rates (prior probabilities) and too little on the new information.


Question 14 - #138261

Which of the following would be considered emotional biases?

A) Blackwood tends to hold onto her losers too long.

B) Blackwood doesn't like fixed-income investments because she doesn't understand them.

C) Blackwood's most valuable lessons were learned through her own mistakes.

A) A type of representativeness bias in which the probability of the categorization is not adequately considered.

B) Found in conservatism bias where the investor places too little weight on new information.

C) When the investor considers the long run average of data and how new information relates to the past data.



Your answer: A was incorrect. The correct answer was C) Status quo and endowment biases.

Status quo and endowment biases are emotional biases whereas the other biases fall under the category of cognitive errors.


Question 15 - #138173

Which of the following statements resembles the behavioral trait of conservatism bias most accurately?


In the conservatism bias investors might be slow to react to new information or may avoid the difficulties associated with analyzing new information and simply stay with previous forecasts. The result may be a tendency to hold winners or losers too long. This is closely related to anchoring and adjustment where Individuals seem to be anchored to a value, such as an expected price or other forecast, as if it has a gravitational pull. Unlike the conservatism bias that has similar effects but is based on how investors relate "new" information to "old" information, anchoring is based on a target number; once individuals have this target in their mind, they seem pulled toward it. The conservatism bias is a cognitive error in belief persistence whereas anchoring and adjustment is a cognitive error in information processing. In this question there is not enough information to determine if the behavioral trait described in the correct answer represents conservatism or anchoring and adjustment. The other two answer choices represent the confirmation bias where the investor dismisses information that is contrary to their beliefs and the representativeness bias. In the representative bias the investor views new information as being representative of past experiences and places the new information into a category based on if-then heuristics.


Question 16 - #138285

Which of the following is least likely a way to reduce overconfidence in analyst forecasts?


Collecting a large amount of data can lead to overconfidence in analysts� forecasts referred to as the illusion of knowledge when the analyst thinks they are smarter than they are. This, in turn, makes them think their forecasts are more accurate than the evidence indicates.

Self-calibration is the process of remembering their previous forecasts more accurately in relation to how

A) Confirmation, control, and availability biases.

B) Anchoring and adjustment bias.

C) Status quo and endowment biases.

A) The investor tends to avoid or ignore information that is contrary to his beliefs.

B) The investor places an incorrect value on information because it readily fits into a category with which he has recent experience.

C) Rather than sell at a small gain, the investor waits for the stock to reach his forecasted target price.

A)The analyst should seek a contrary opinion to their forecast based on evidence along with using a large enough sample size and Bayes� formula.

B) Gather a large amount of data from which to develop a forecast.

C) The analyst is properly self-calibrated through feedback from colleagues and superiors along with a structure that rewards accuracy and forecasts that are unambiguous and detailed.



close the forecast was to the actual outcome. Getting prompt and immediate feedback through self evaluations, colleagues, and superiors, combined with a structure that rewards accuracy, should lead to better self-calibration. Analysts� forecasts should be unambiguous and detailed, which will help reduce hindsight bias.

Analysts should seek at least one counterargument, supported by evidence, for why their forecast may not be accurate. They should also consider sample size. Basing forecasts on small samples can lead to unfounded confidence in unreliable models. Lastly, Bayes� formula is a useful tool for reducing behavioral biases when incorporating new information.



According to behavioral finance, which of the following best describes how investors will invest their retirement portfolio?

Your answer: B was incorrect. The correct answer was C) The investor will put an equal dollar amount in each mutual fund on the menu of their employer抯 defined contribution plan.

According to behavioral finance, investors will diversify the portfolio for their defined contribution pension using 1/n diversification. In 1/n diversification, an employee puts an equal amount in each fund on the employer抯 defined contribution pension plan menu. For example, if there are eight mutual funds available, the employee will put one-eighth of their contribution in each fund. Note that in the U.S., an employer cannot force an employee to put more than 10% of their retirement funds in company stock.


Question 18 - #138282

Gina Arturo has an online brokerage account in which she frequently places trades. Which of the following behavioral traits is she most likely exhibiting?

Your answer: A was incorrect. The correct answer was B) Overconfidence.

When retail investors trade their brokerage accounts excessively this is thought to be caused by overconfidence based on a false sense of insight into the investment抯 future performance. The typical result is lower overall returns due to trading costs as well as from selling winners too soon and holding losers too long. Selling winners too soon and holding onto losers too long is called the disposition effect. There is no evidence in this question that Arturo is exhibiting the disposition effect. Many retail investors also typically display the home bias effect which is the behavioral trait of investors placing a high proportion of their assets in the stocks of firms in their own country. This is closely related to familiarity where investors invest in stocks they are familiar with such as domestic stocks or their own company stock.

A)The investor will put most of their money in the less risky assets on the menu of their employer抯 defined contribution plan.

B)The investor will put most of their money in the less risky assets on the menu of their employer抯 defined contribution plan unless the employer forces them to put the majority of the funds in the company抯 stock.

C)The investor will put an equal dollar amount in each mutual fund on the menu of their employer抯 defined contribution plan.

A) Disposition effect.

B) Overconfidence.

C) Home bias effect.





Mike McLaughlin is an economist who makes quarterly forecasts for the state of the economy and interest rates. Last quarter, the economy did not grow as fast as McLaughlin predicted. McLaughlin explains that his forecast was inaccurate by stating 揟his change in the economy was due to a real estate market that slowed faster than many forecasters, including myself, expected. If it weren抰 for the real estate market, my projection for GDP would have been accurate.� Which of the following is the best interpretation of McLaughlin抯 statement, from a behavioral finance view? McLaughlin is using:

Your answer: B was incorrect. The correct answer was C) a self attribution defense for his inaccurate forecasts and this will prevent him from accurately evaluating his own abilities.

McLaughlin is using a self-attribution bias which is an ego defense mechanism where analysts take credit for their successes and blame others or external factors for their failures. According to behavioral finance, analysts will use excuses to justify their inaccurate forecasts. These excuses will prevent them from accurately evaluating their own abilities. As a result, they will persist in making the same mistakes. Hindsight bias is when the analyst selectively recalls details of the forecast and reshapes it in such a way that it fits the outcome.


Question 20 - #138286

Which of the following statements best reflects the relationship between company management presenting reports in a favorable light and analysts� forecasts?


The way a company抯 management presents (frames) information can influence how analysts interpret it and include it in their forecasts. There are three cognitive biases frequently seen when management reports company results: (1) framing, (2) anchoring and adjustment, and (3) availability.

Framing refers to a person抯 inclination to interpret the same information differently depending on how it is presented. In the case of company information, analysts should be aware that a typical management report presents accomplishments first.

Anchoring and adjustment refers to being 揳nchored� to a previous data point. The way the information is framed (presenting the company抯 accomplishments first), combined with anchoring (being overly influenced by the first information received), can lead to overemphasis of positive outcomes in forecasts.

Availability refers to the ease with which information is attained or recalled. The enthusiasm with which managers report operating results and accomplishments makes the information very easily recalled and, thus,

A) an 搃f-only� defense for his inaccurate forecasts and his recognition of it will sharpen his abilities.

B) hindsight bias as a defense for his inaccurate forecasts and this will prevent him from accurately evaluating his own abilities.

C) a self attribution defense for his inaccurate forecasts and this will prevent him from accurately evaluating his own abilities.

A) The way company management presents reports generally influences analysts because they are also susceptible to behavioral biases.

B) The way company management presents reports influences analysts but they possess the skills to be able to mitigate the influence by company management.

C) Analysts can be unduly influenced by the way management presents and frames company reports thus analysts should be aware of the various biases management can be susceptible to.



more prominent in an analyst抯 mind.

Analysts should also look for self-attribution bias in which management has overemphasized the positive as well as the extent to which their personal actions influenced the operating results leading to excessive optimism (overconfidence).

To help avoid the undue influence in management reports, analysts should focus on quantitative data that is verifiable and comparable rather than on subjective information provided by management. The analyst should also be certain the information is framed properly and recognize appropriate base rates (starting points for the data) so the data is properly calibrated.


Question 21 - #138272

Limitations of classifying investors into behavioral types would include all of the following EXCEPT:


The client portfolio constructed by the adviser not falling on the efficient frontier (the rational portfolio) is not a limitation but the result of classifying an investor into a behavioral type. It results in a portfolio that is better suited to the client given their behavioral biases. Limitations of classifying investors into the various behavioral investor types include:

Individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.

An individual might display traits of more than one behavioral investor type, making it difficult to place the individual into a single category.

As investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.

Even though two individuals may fall into the same behavioral investor type, the individuals should not necessarily be treated the same due to their unique circumstances and psychological traits.

Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don抰 all act irrationally (or rationally) at the same time.


Question 22 - #138175

Which of the following statements best exemplifies the difference between behavioral and traditional finance? Traditional finance:

A) individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.

B) the resulting client portfolio is not the 搑ational� portfolio.

C) as investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.

A) does not take into consideration the behavioral aspects of investing which if considered would lead to better portfolio construction.

B) views portfolio construction from an historical perspective whereas behavioral finance incorporates modern up-to-date techniques in the portfolio construction process.

C) assumes investors make rational decisions whereas behavioral finance attempts to explain why investors act the way they do.




Traditional finance assumes investors exhibit risk aversion and make unbiased, utility-maximizing rational decisions. Behavioral finance assumes investors employ some combination of traditional finance and psychological biases when making investment decisions and attempts to explain why investors make the decisions they do.


Question 23 - #138177

Assume there are two investments to choose from: investment A has an expected return of 10% and a standard deviation of 15%, and investment B also has an expected return of 10% but its standard deviation is 20%. The risk neutral investor would:

Your answer: B was incorrect. The correct answer was C) choose either investment A or B since they are not concerned about the level of risk but only with the level of return.

Given two alternatives with the same expected return but different levels of risk (i.e., different standard deviations), the risk-neutral investor would be indifferent between the two alternatives, the risk-averse investor will select the alternative with less risk, and a risk-seeking investor would actually prefer (derive more utility from) the riskier alternative.



Defining investor objectives in terms of mean and standard deviation:


Defining investor objectives in terms of mean and standard deviation may make selecting an asset allocation more difficult for the individual, since it can be hard to see how the choices affect the probability of success. In addition, this method of goal definition often makes it can make it difficult to estimate the probability that the objectives will be realized, and may make it more likely that deviations from policy will occur.


Question 25 - #138273

Which of the following is least likely a limitation of classifying an investor into a behavioral type?

A) choose investment A because it has a higher return for a given level of risk.

B) not choose investment B because it has a higher level of risk with no additional compensation.

C) choose either investment A or B since they are not concerned about the level of risk but only with the level of return.

A) may make it easier to estimate the probability that the objectives will be realized.

B) usually makes it less likely that the investor will deviate from the investment policy because of current market conditions.

C) may make selecting an asset allocation more difficult for the individual.

A) The client portfolio constructed by the adviser most likely will not fall on the efficient frontier.

B) Even though two individuals may fall into the same behavioral investor type, the individuals should not necessarily be treated the same due to their unique circumstances and psychological traits.



Your answer: A was correct!

The client portfolio constructed by the adviser not falling on the efficient frontier is not a limitation but the result of classifying an investor into a behavioral type. It results in a portfolio that is better suited to the client given their behavioral biases. Limitations of classifying investors into the various behavioral investor types include:

Individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.

An individual might display traits of more than one behavioral investor type, making it difficult to place the individual into a single category.

As investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.

Even though two individuals may fall into the same behavioral investor type, the individuals should not necessarily be treated the same due to their unique circumstances and psychological traits.

Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don抰 all act irrationally (or rationally) at the same time.



Kelly Lieb and Don Carsner are discussing their investments in the Shrader Tire 401(k) defined contribution plan. Lieb and Carsner make the following statements in their conversation:

Which of the following factors behind holding company stock best reflects Lieb抯 comment and Carsner抯 comment respectively?


Even without direct encouragement by the plan sponsor, employees tend to invest more in their company抯 stock that would be warranted from a diversification standpoint. Lieb抯 and Carsner抯 comments are reflective of the two primary factors that contribute to DC plan participants holding company stock: framing and familiarity bias. Lieb抯 comment reflects framing which refers to the misconception that by matching the employee's contribution with company stock the sponsor is implicitly endorsing it as a good investment. Carsner抯 comment is reflective of familiarity bias, which refers to investors selecting stocks with which they are comfortable with or have a proximity to. If company stock is offered as an investment option in a defined contribution plan, participants may feel a sense of control or allegiance to the firm and hold more company

C)Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don抰 all act irrationally (or rationally) at the same time.

Lieb: "Most of the money I have invested in our 410(k) plan is in Shrader Tire stock. Management would not give it to us as a company match if it were not a good investment.

Carsner: "I allocate most of my money to Shrader Tire Company stock as well. I don't know anything about the other investment options, and I want to be loyal to the company."

Lieb's Comment Carsner's Comment

A) Familiarity bias Familiarity bias

B) Framing Framing

C) Framing Familiarity bias



stock than is sensible, which is an effect of familiarity.



According to prospect theory, investors are generally more concerned with:


Behavioral investors are generally more concerned with avoiding losses, which implies that risk of loss may be the best measure of risk.


Question 28 - #138266

Dan Chechele is getting nervous that the market has experienced several consecutive days of losses and is getting uncomfortable having experienced many market downturns throughout his lifetime. Based on his past experience he is subconsciously putting the recent market activity into the category of a market trend. Which of the following biases is Chechele exhibiting?


In the representativeness bias individuals classify information into subjective categories using heuristics; they place new information into the most appropriate category based on personal experiences. Think of representativeness as an if-then or stereotype heuristic. Investors feel that 搃f� information looks a certain way, 搕hen� it fits into a certain category. The if-then heuristic is based on past experiences and on relationships the investor has witnessed, such as a past market trend. In that case, recent upward or downward movements in the market are classified as market trends with implications for performance of the market and individual stocks. The confirmation bias is when individuals tend to notice only information that agrees with their perceptions or beliefs. They look for confirming evidence while discounting or even ignoring evidence that contradicts their beliefs or their perceptions. The loss aversion bias is when individuals focus on potential gains and losses relative to risk rather than returns relative to risk. They place more 搗alue� on losses; the reduction in utility caused by a loss is greater than the increase in utility provided by a gain of the same magnitude. Thus, when considering a risky investment, investors exhibit loss aversion rather than risk aversion, as assumed in portfolio theory.


Question 29 - #138271

Which of the following are uses of classifying investors into various types? Classifying investors into behavioral types:

A) fear of regret, which suggests that the prospect for outperforming a benchmark is the primary concern for these investors.

B) avoiding losses, which suggests that risk of loss may be the best measure of risk.

C) diminishing marginal utility, which suggests that expected return is more important than risk to these investors.

A) Representativeness bias.

B) Confirmation bias.

C) Loss aversion bias.




The goal of viewing the client/adviser relationship from a psychological perspective as compared to a purely traditional finance perspective is for the adviser to better understand their client and to make better investment decisions. By incorporating behavioral biases into clients� IPSs, clients� portfolios will tend to be closer to but not on the efficient frontier (the rational portfolio), and clients will be more trusting and satisfied and tend to stay on track with their long-term strategic plans. Ultimately, since everyone is happy, the result is a better overall working relationship between client and adviser. Clients who are at the extremes of risk aversion tend to approach investing very emotionally and are not interested in traditional finance concepts therefore educating them on these concepts is of little value to them and does not work.


Question 30 - #138290

Heather Jones graduated from a prestigious Ivy League college in May, recently passed Level I of the CFA exam, and just landed her first professional job as a junior portfolio manager working with CFA charterholders for the Fortress mutual fund company. She works in a group setting comprised of a lead portfolio manager and one or more co- or junior portfolio managers who together make the investment management decisions for a single mutual fund. Jones has observed the following behavior during the committee meetings where the portfolio managers discuss which investments should be a part of the portfolio: analyst A always sides with and follows the lead of analyst B, analyst C tends to have a different opinion from the group view but fears being ostracized therefore he rarely voices his opinion, manager D is very aggressive and shoots down the opinions of others if they contradict his own and also likes to argue with people. Jones is starting to wonder whether or not she made the right decision by taking the job and has had several thoughts about the behavior at the meetings. Which of the following of her thoughts is least reflective of how financial decisions are typically made in a group setting?

Your answer: C was incorrect. The correct answer was A) 揇ecisions made at this level are made by professionals with similar backgrounds, the committee should be functioning in a more efficient and effective manner with little discord among the members!�

In a group setting individual biases can be either diminished or amplified with additional biases being created. Research has shown that the investment decision making process in a group setting is notoriously poor. Committees do not learn from past experience because feedback from decisions is generally inaccurate and slow, so systematic biases are not identified.

The typical makeup of a committee coupled with group dynamics leads to the problems normally seen with committees typically comprised of people with similar backgrounds thus they approach problems in the same manner leading the group to start thinking as a single individual, individuals can sometimes follow the beliefs of a group, and some individuals may feel uncomfortable expressing their opinion if it differs with others or a powerful member of the group.


A) helps the advisor understand their client resulting in better overall investment decisions being made that are closer to the efficient frontier.

B) allows the advisor to have a better understanding of how to approach their client when educating them on traditional finance concepts.

C)gives the adviser the tools to be able to explain to the client why their portfolio should resemble the 搑ational portfolio� based on traditional finance concepts.

A)揇ecisions made at this level are made by professionals with similar backgrounds, the committee should be functioning in a more efficient and effective manner with little discord among the members!�

B) 揟hese people are displaying irrational behavior which is typical of group settings!�

C) 揟heir individual behavioral biases have become exacerbated in the group setting!�




Many defined contribution plan participants tend to hold a large amount of assets in company stock relative to other asset classes. Which of the following characteristics of a DC plan participant抯 portfolio best reflects the reason behind this tendency?

Your answer: A was incorrect. The correct answer was C) Familiarity.

DC participants tend to hold excess stock of the company they work for due to familiarity which is the tendency for individuals to invest in where they are most comfortable or familiar which could be the company they work for. Naive diversification is allocating an equal amount of retirement savings to each investment option. Note that the status quo bias refers to a lack of action on the part of the participant.



Brian Piezer is a participant in the NSS Enterprises 401(k) plan and started contributing to the plan in 1998. Piezer抯 portfolio allocation when he started the plan in 1998 was as follows:

In March of 2000, the equity markets started to decline, eventually hitting a low point in October 2002. Piezer抯 investment allocation in 2002 is below:

Which of the following characteristics of a DC plan participant抯 portfolio is most reflective of Piezer抯 in 1998 and 2002 respectively?


A) Status quo bias.

B) Naive diversification.

C) Familiarity.

Allocation Investment Option

20% Reliant Large Cap Growth Fund

20% Reliant Small Cap Value Fund

20% Reliant Intermediate Bond Fund

20% Reliant Money Market Fund

20% Reliant International Stock Fund


8% Reliant Large Cap Growth Fund

10% Reliant Small Cap Value Fund

36% Reliant Intermediate Bond Fund

30% Reliant Money Market Fund

10% Reliant International Stock Fund

Portfolio in 1998 Portfolio in 2002

A) Framing 1/n diversification bias

B) Framing Status quo bias

C) 1/n diversification effect Status quo bias



Piezer抯 portfolio in 1998 is reflective of 1/n diversification � the allocation is divided equally among the 5 funds. Often times, participants will only have a basic understanding of diversification and will simply divide their assets equally over the investment options in the plan in order to effectively diversify their portfolio. The portfolio in 2002 is reflective of the status quo bias, which refers to a participant抯 tendency to make an original allocation and not change it. With the bear market from 2000 � 2002, it appears that Piezer抯 allocation to equities went down dramatically as equities decreased in value, thus increasing his weighting in the money market and bond fund. There does not appear to be any attempts to rebalance or change his allocation.


Question 33 - #138166

The isolation effect seen in the editing phase of prospect theory is thought to be the result of:


Prospect theory proposes that investors make decisions in two phases: editing and evaluation. In the editing phase, investors clarify choices using some combination of six possible steps: codification, combination, segregation, cancellation, simplification, and detection of dominance. In the cancellation step, investors eliminate (ignore) possible outcomes common to choices, so they might focus on low-probability, large outcomes. By focusing on the large, low-probability outcomes, they exhibit isolation (i.e., they isolate and make decisions based on certain outcomes).


Question 34 - #138262

Which of the following cognitive errors would be due to belief persistence?


Mental accounting, framing, and availability biases are information processing biases whereas conservatism, representativeness, and hindsight biases are belief persistence biases. The conservation bias is made up.


Question 35 - #138171

When an investor considers wealth fungible:

A) dominance.

B) cancellation.

C) combination.

A) Control, confirmation, and conservation biases.

B) Mental accounting, framing, and availability biases.

C) Conservatism, representativeness, and hindsight biases.

A) he will put investments into separate mental accounts.

B) he may create and hold a single portfolio to meet lifetime consumption.

C) he will create a layered portfolio with each layer consisting of different assets designated to meet a specific goal.



Your answer: B was incorrect. The correct answer was A) he will put investments into separate mental accounts.

Fungible means that wealth is interchangeable. By assuming individuals create a single portfolio to meet their lifetime obligations, for example, individuals must assume wealth is fungible. The same wealth can be used to meet any needs. By thinking of wealth in terms of separate mental accounts, the individual implicitly assumes it is not fungible; specific wealth is dedicated to specific goals. This is also the concept behind layered portfolios.



Which of the following is least likely a heuristic learning process?

Your answer: C was incorrect. The correct answer was A) Research.

Trial and error, and experimentation are heuristic learning processes. Heuristic learners pick up information simply, through their own efforts or from sources simple to access. They don't do research.



Steve Perlewitz, a retirement plan specialist for Mercantile Asset Advisors (MAA), is discussing the behavioral characteristics of individual investors in defined contribution retirement plans in an effort to educate MAA抯 sales team as they sell MAA抯 services. In his presentation, Perlewitz makes the following comments:

After listening to Perlewitz抯 presentation, sales team leader Vicki Bruning would be CORRECT to agree with:

Your answer: B was incorrect. The correct answer was C) Comment 3 only.

A) Research.

B) Experimentation.

C) Trial and error.

Comment 1:�

An investor whose decisions are impacted by mental accounting are likely to hold on to losing investments too long, and sell winning investments too soon.

牋Comment 2:�

Since mental accounting tends to guide investors toward more conservative asset classes, the portfolio of an investor impacted by mental accounting will tend to be more conservative than that of an investor who is not, assuming similar return objectives.

牋Comment 3:�

The 1/n diversification methodology used by many DC plan participants is an example of na飗e diversification.

牋Comment 4:�

營f a defined contribution plan investor has an appropriate allocation in their retirement plan, the same allocation should also apply to their other investment accounts.

A) Comments 1, 2, and 4 only.

B) Comments 2 and 3 only.

C) Comment 3 only.



Perlewitz is only correct with respect to Comment 3. With 1/n diversification, where a DC plan participant divides his investment dollars equally across available investment options, diversification is by chance only and is not part of a total portfolio perspective. Such a diversification methodology is reflective of na飗e diversification. The other comments are incorrect. An investor whose decisions are impacted by mental accounting will look at investments as separate, focusing on the risk of investments in isolation. This means that the investor dismisses the effects of correlation, thus leading to more risky portfolios than an investor who does consider correlation. Note that the disposition effect refers to holding on to losing investments too long and selling winners too soon. Finally, diversification from an efficient perspective may allocate investments in tax-deferred accounts (like a retirement plan) differently than investments in taxable accounts, while still focusing on the investor抯 allocation as a whole.


Question 38 - #138270

Which of the following does NOT reflect the most likely asset allocation as a result of incorporating behavioral biases into the portfolio construction process?

Your answer: A was incorrect. The correct answer was C) Create a portfolio in which all of the investor抯 assets are viewed together taking the correlation between those assets into consideration assigning a single measure of risk to the portfolio.

The correct answer choice reflects portfolio construction based on traditional finance theory which assumes investors make rational decisions and are not influenced by behavioral biases.

In attempting to either mitigate or accommodate behavior biases goals-based investing recognizes that individuals are subject to loss aversion and mental accounting. Applying goals-based investing, the investor builds a portfolio in layers, one layer at a time. Each layer of the portfolio consists of assets used to meet individual goals or subsets of goals. Looking at the portfolio as if it were a pyramid, the bottom layer of the pyramid is constructed first and is comprised of assets designated to meet the investor抯 most important goals. Once this foundation layer is constructed, the investor moves to the next layer. Each successive layer as you move up the pyramid consists of increasingly risky assets used to meet less and less import goals. Structuring the portfolio in this manner provides the investor with the ability to see risk more clearly. Although from an efficient frontier perspective the portfolio probably won抰 end up efficient, it will tend to be fairly well diversified.

Behaviorally modifying a portfolio simply means constructing it according to the investor抯 behavioral risk and return preferences. The strategy portfolio is probably not efficient from a modern portfolio theory perspective, but the investor is comfortable with it and will, thus, be more likely to adhere to the strategy. The construction of the modified portfolio considers the investor抯 emotional and cognitive behavioral biases and current wealth.


Question 39 - #138165

Which of the following actions is most likely the result of applying Bayes� theorem of conditional probability? A fundamental analyst revises a stock recommendation when:

A)Arrange the assets that relate to the investor抯 specific goals in layers resembling a pyramid with the most conservative assets in the bottom layer and the most risky assets at the top.

B) Create a portfolio that accommodates the investor抯 behavioral risk and return preferences.

C)Create a portfolio in which all of the investor抯 assets are viewed together taking the correlation between those assets into consideration assigning a single measure of risk to the portfolio.

A) she revises her inflation expectations.

B) the firm issues an earnings report.




A fundamental analyst bases recommendations on firm or market fundamentals such as expected earnings. The fire would signal an unexpected change in the firm抯 fundamentals as would a revised earnings announcement. Revising a recommendation based on the probability of a given level of inflation is an example of applying a Bayesian framework to an expectation. That is, the firm抯 performance is based conditionally on the probability of a given level of inflation.


Question 40 - #138281

Investor X works for company A and investor Y works for company B. Company A makes a matching contribution into their employees� retirement funds in cash whereas company B matches with company stock. Which of the following are the most likely behavioral traits exhibited by both employees?


Research has shown that employees who can choose where the employer match is invested allocate a smaller amount of their own funds to their employer抯 stock than when the employer match is made with company stock. In other words the employee who is receiving a retirement match in company stock is more likely to purchase more company stock with their own funds than an employee who receives a retirement match in cash. This behavioral bias is a type of framing because the employee may be interpreting the company抯 match in company stock as implicit advice regarding the stock.



An investor is averse to experiencing losses. Which of the following behaviors will result from the loss aversion? It will lead to:


If an investor is loss averse, they may become risk-seeking in order to make up their losses quickly. They would do so by investing in more risky assets that have a chance of high returns that would cover the losses.


Question 42 - #138180

Which of the following statements best defines satisfice?

C) the firm experiences a major fire that destroys its production line.

A) Investor Y will purchase more company stock than investor X.

B)Both investor X and Y will purchase company stock in approximately the same proportions so the final allocation of company stock is actually higher in investor Y抯 plan.

C) Investor X will purchase more company stock than investor Y with the final proportions being approximately equal in their retirement plans.

A) the buying of loser stocks.

B) risk-seeking behavior.

C) risk-aversion behavior.



Your answer: C was incorrect. The correct answer was B) Investors make a satisfactory choice based on the information gathered.

Satisfice means the investor gathers what they consider to be an adequate amount of information and apply heuristics to analyze the information into an acceptable decision which is not necessarily the optimal decision from a traditional finance perspective. The traditional finance perspective would instead gather and meticulously analyze all relevant information to make the utility maximizing choice.


Question 43 - #138292

When an investor extrapolates past data from a small sample size into a forecast this is most likely indicative of:

Your answer: B was incorrect. The correct answer was A) the recency bias.

Herding is when investors trade in the same direction or in the same securities, and possibly even trade contrary to the information they have available to them. Two behavioral biases associated with herding are the availability bias (a.k.a. the recency bias or recency effect) and fear of regret. In the availability bias, recent information is given more importance because it is most vividly remembered. It is also referred to as the 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. In the context of herding, the recent data or trend is extrapolated by investors into a forecast.

Regret is the feeling that an opportunity has passed by and is a hindsight bias. The investor looks back thinking they should have bought or sold a particular investment (note that in the availability bias, the investor most easily recalls the recent positive performance). Regret can lead investors to buy investments they wish they had purchased, which in turn fuels a trend-chasing effect. Chasing trends can lead to excessive trading, which in turn creates short-term trends.

This question tested from Session 3, Reading 9, LOS f.

Question 44 - #138263

Which of the following cognitive errors would be due to information processing?


Anchoring and adjustment is a cognitive information processing bias whereas all the other biases listed are emotional biases.


A) The investor gathers adequate information to make the utility maximizing choice.

B) Investors make a satisfactory choice based on the information gathered.

C) Making a decision in which you are satisfied.

A) the recency bias.

B) fear of regret.

C) hindsight bias.

A) Loss aversion, overconfidence, and self-control biases.

B) Anchoring and adjustment bias.

C) Status quo, endowment, and regret-aversion biases.




An investor selling winning securities too soon and holding losing positions too long is an example of:


This is the definition of the disposition effect.



Leonard Busch is a employee of Matrix Technologies, and a participant in the Matrix Technologies defined contribution plan. The assets in the plan are the only investments he owns. Busch抯 investment allocation is shown below.

Which of the following factors is most likely to drive Busch抯 investment allocation?


Looking at Busch抯 allocation, he obviously has a disproportionate amount of Matrix Technologies company stock. DC participants tend to hold excess stock of the company they work for due to familiarity and a perceived endorsement by management. Familiarity refers to investors selecting stocks with which they are comfortable with or have a proximity to. If company stock is offered as an investment option in a defined contribution plan, participants may feel a sense of control or allegiance to the firm and hold more company stock than is sensible, which is an effect of familiarity. Note that Busch抯 assets are not equally divided among investment options, which means the 1/n diversification heuristic would not seem to apply. Status quo bias is clearly not the best answer given the weight in company stock.


Question 47 - #138170

An individual is presented with a number of choices, with only two outcomes each: one positive and one negative. If the individual抯 selection is affected by whether only the positive or negative outcome of each choice is stated, the individual is most likely subject to the behavioral characteristic known as:

A) the disposition effect.

B) representativeness.

C) overconfidence.


20% Yukon Large Cap Growth Fund

40% Matrix Technologies Company Stock

15% Yukon Intermediate Bond Fund

10% Yukon Money Market Fund

15% Yukon International Stock Fund

A) Familiarity.

B) Status quo bias.

C) 1/n diversification heuristics.

A) self-control bias.



Your answer: C was incorrect. The correct answer was B) framing.

Framing refers to the way information is presented or perceived and can affect the way individuals view choices. Due to loss aversion, an investor抯 selections will be affected by whether the outcome is stated in terms of the possible loss or in terms of the possible gain. Self-control bias refers to the individual抯 inability to resist the expected utility of current consumption. Consuming now and not saving for the future can lead to suboptimal lifetime consumption. Mental accounting refers to the individual抯 tendency to place goals into mental files with a portion of wealth dedicated to each goal. In this way, it leads to layered portfolios.


Question 48 - #138181

To satisfice means the investor:


To satisfice is the process of gathering and utilizing information that helps the investor take intermediate steps towards their goals. They do not gather and analyze all the information available to them but instead use heuristics, trial and error learned behavior, and the information they have gathered to make a decision they are satisfied with which is most likely not the optimally maximizing portfolio.


Question 49 - #138169

Basing trading decisions on available public information, Carla Maplewood, CFA, is consistently able to identify and profit on mispriced securities. Based on her successful trading strategy, we would most likely conclude that the market is at best:

Your answer: A was incorrect. The correct answer was C) weak-form efficient.

In a semi-strong form efficient market, where prices incorporate all available public information, investors should not be able to consistently generate excess returns by using public information alone. If the market is not semi-strong form efficient, it cannot be strong-form efficient. At best, the market could be considered weakly efficient.


Question 50 - #138283

Jack Melby places his investments into different 搈ental accounts� with each investment being tied to accomplishing a different goal. All the investments together comprise a pyramid where the most conservative

B) framing.

C) mental accounting.

A) achieves intermediate goals that lead to the utility maximizing choice.

B) takes steps to achieve intermediate goals that help them get closer to the desired goal.

C) gathers all the relevant information available to them and using heuristics they make the optimally maximizing decision.

A) semi-strong form efficient.

B) strong-form efficient.

C) weak-form efficient.



investments are on the bottom layer to meet his most immediate and important goals. Riskier investments are represented higher up in the pyramid and used to meet less immediate goals. This behavioral trait is:

Your answer: C was incorrect. The correct answer was B) not the most efficient from a traditional finance perspective but acceptable because the portfolio tends to be fairly well diversified and if constructed properly from a behavioral finance perspective will help the client stay on track with their long term investing goals.

Investors exhibit behavioral biases when they construct portfolios in layers, comprising a pyramid with each layer having a specific purpose in achieving a different goal. This is also referred to as mental accounting because the assets in each layer of the pyramid are viewed separately from each other with no regard to how they are correlated. In the pyramid structure, the most pressing goals are placed on the bottom layer and are met using low-risk, conservative investments. Each successive layer going toward the top of the pyramid is comprised of riskier assets to accomplish less immediate or less important goals. In the pyramid approach, investors see each layer as having a separate level of risk. Advisers with clients who view their portfolios in layered pyramids can help them understand which mental accounts they have and the risk the client is assigning to each account.

This is in contrast to traditional finance theory, which constructs a portfolio based on viewing the assets as working together as one unit, taking into consideration the correlation between those assets. In this scenario, the portfolio is viewed as having a single measure of risk.



According to behavioral finance, analysts often make excuses for their inaccurate predictions. Which of the following best represents the problem with this occurrence, from a behavioral finance view?


According to behavioral finance, analysts often make excuses for their inaccurate predictions. The excuses will prevent them from recognizing their own limitations and allow them to continue to make inaccurate forecasts. Although there is an element of truth in the other responses, they are not the central problem in this case, according to behavioral finance.


Question 52 - #138277

Which of the following is least likely a way the success of the client / adviser relationship is measured?

A) perceived as being inefficient and the investment adviser should try to persuade the investor to allocate their assets to resemble an allocation based on traditional finance theory.

B)not the most efficient from a traditional finance perspective but acceptable because the portfolio tends to be fairly well diversified and if constructed properly from a behavioral finance perspective will help the client stay on track with their long term investing goals.

C)called 搈ental accounting� and is not thought to be an acceptable way for investors to allocate their assets.

A) The excuses allow poor forecasters to stay in their positions when they should be replaced.

B) The excuses will prevent analysts from recognizing their own limitations.

C) Other investors depend on these forecasts, resulting in aggregate investment losses.

A) The adviser acts as the client expects.

B) Both client and adviser benefit from the relationship.

C) The adviser has been able to successfully grow their business year after year.



Your answer: A was incorrect. The correct answer was C) The adviser has been able to successfully grow their business year after year.

The success of the typical client/adviser relationship can be measured in four areas with each one being enhanced by incorporating behavioral finance traits:

1. The adviser understands the long-term financial goals of the client. 2. The adviser maintains a consistent approach with the client. 3. The adviser acts as the client expects. 4. Both client and adviser benefit from the relationship.



Bobby Steele, a software engineer at a local firm, has been investing for the past two years and has been very successful. He shuns professional investment advice and in fact provides advice to his neighbors and friends. He states that his investment philosophy consistently outperforms the experts. Which of the following best describes the implications of Steele抯 investment style?

Your answer: B was incorrect. The correct answer was C) Steele is likely to have high turnover in his portfolio and is likely to make unjustified bets.

Steele is an overconfident investor. As a result, he will have high turnover in his portfolio because he will believe that he can accurately forecast the future performance of stocks. He will also make bets that are unjustified because he does not understand that he does not possess all the information necessary to form unbiased projections.



Jill Davis tells her broker that she does not want to sell her stocks that are below the price she paid for them. She believes that if she just holds on to them a little longer they will recover, at which time she will sell them. What behavioral characteristic does Davis have as the basis for her decision making?


Davis uses loss aversion as the basis for her decision making. She holds on to stocks that are down from the purchase price in the hopes that they will recover. She is reluctant to accept a loss.



Some proponents of behavioral finance believe that investors structure their portfolios as pyramids. Which of

A) Steele is likely to have low turnover in his portfolio and is likely to make unjustified bets.

B) Steele is likely to have low turnover in his portfolio and is likely to base stock valuation on fundamental analysis.

C) Steele is likely to have high turnover in his portfolio and is likely to make unjustified bets.

A) Conservatism.

B) Representativeness.

C) Loss aversion.



the following best represents the resulting structure of their portfolios?


Investors will structure their portfolios as pyramids, with the bottom layer invested in less risky assets to fund necessities. Once necessities are funded, higher levels of the pyramid are dedicated towards riskier investments.


Question 56 - #138288

Which of the following best exemplifies the structure of a committee that effectively makes decisions?


Effectively functioning groups would have the following features:

Be comprised of individuals with diverse backgrounds. Have members who are not afraid to express their opinions even if it differs from others. Have a committee chair that encourages members to speak out even if the member抯 views are

contrary to the group抯 views. A mutual respect for all members of the group.



Defining investor objectives in terms of mean and standard deviation:

Your answer: B was incorrect. The correct answer was C) can make it difficult to estimate the probability that the objectives will be realized.

Defining investor objectives in terms of mean and standard deviation can make it difficult to estimate the probability that the objectives will be realized. Therefore, this also often makes it more difficult for the investor to see the connection between policy and their own goals, and may make it more likely that deviations from policy will occur. It also simplifies the process for the investment advisor.

A)The bottom layer of an investor抯 pyramid will be invested in stock with higher layers invested in bonds and cash.

B) Several pyramids of different sizes will be formed, each representing a different funding requirement.

C)The bottom layer of an investor抯 pyramid will be invested in bonds and cash with higher layers invested in stock.

A) The committee members get along well and there is little animosity or in-fighting between the committee members.

B) The committee members are encouraged to speak out so different opinions are heard.

C)The committee is comprised of individuals from different backgrounds and where the committee chair encourages people to voice their opinions even if it is contrary to the group抯 view.

A) will increase the complexity of the process for the investment advisor.

B)may make it easier for the investor to make a connection between the investment policy and the investor抯 own goals.

C) can make it difficult to estimate the probability that the objectives will be realized.





Which of the following statements most correctly describes the shift in focus when moving from a traditional finance to a behavioral finance investment process, and what is the most pronounced result of this shift?

Your answer: C was incorrect. The correct answer was A) The goal definition shifts from statistical measures of risk and return to lifestyle-based objectives, and the most pronounced result is that the definition of risk changes from dispersion-based measures to the probability that the stated objectives will be realized.

The primary shift is from the traditional performance concepts of expected return and dispersion-based measures of risk, to defining performance in terms of the realization of lifestyle-based objectives. The most pronounced result is that new measures of risk are required, and the new risk measures are concerned with whether or not the stated objectives are realized.


Question 59 - #138176

What is the purpose of using Baye抯 formula in the investment decision making process?


Baye抯 formula measures the probability of an event occurring given the probability of some other event occurring. It is used in the forecasting process, for example new information about a stock would be incorporated into a revised forecast aiding in determining whether or not to buy or sell the stock. Using Baye抯 formula should result in more accurate forecasts.



All of the following are potential benefits of defining portfolio objectives in terms of client objectives EXCEPT:


A)The goal definition shifts from statistical measures of risk and return to lifestyle-based objectives, and the most pronounced result is that the definition of risk changes from dispersion-based measures to the probability that the stated objectives will be realized.

B)The definition of investor motives shifts to a focus on emotions, and the most pronounced result is that the definition of risk changes from dispersion-based measures to the probability that the stated objectives will be realized.

C) The definition of investor motives shifts to a focus on emotions, and the most pronounced result is the development of measures to quantify how emotions affect the asset allocation process.

A) Incorporate some quantitative aspects into the portfolio construction process.

B) Incorporate new information into previous forecasts updating those forecasts which aids in the investment decision making process.

C) Assign probabilities to various outcomes helping the investor gain insight into the range of those possible outcomes.

A) it allows the investor to better connect the probability of goal attainment with investment policy.

B) the optimal portfolio can then be determined analytically.

C) it may improve the likelihood that the investor will adhere to investment policy.



Choosing the optimal portfolio is still a matter of judgement梐 tradeoff between risk and return, but the specification of risk is often much easier for the investor to understand. Both remaining statements are correct.


©2011 Kaplan Schweser. All Rights Reserved.

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