Test bank fundamentals of corporate finance 9th edition chap022

Within a very brief period, it wasobvious that Amy had made a very bad decision in opening those stores, given that the economy is in the middle of a severe recession.. The tendency for

Behavioral Finance: Implications for Financial Management

Multiple Choice Questions

1 Amy is the chief financial officer of a retail toy store Recently, she decided that the firm should expand its operations and open two additional stores Within a very brief period, it wasobvious that Amy had made a very bad decision in opening those stores, given that the

economy is in the middle of a severe recession In reflecting back on her decision, Amy realizes that she made a bad decision due to a reasoning error Which one of the following areas of study best applies to this situation?

2 Peter has successfully managed the finances of A.D Leadbetter in a manner that has

yielded abnormally high returns Due to this success, Peter has decided to publish a newsletterfor financial executives so that he can share his superior financial wisdom with others There

is a very real probability that Peter has which one of the following characteristics?

A gambler's fallacy

B frame dependence

C overconfidence

D representativeness heuristic

E sentiment-based risk attitudes

3 Anytime Ted analyzes a proposed project, he always assigns a much higher probability of success to the project than is warranted by the information he has gathered Ted suffers from which one of the following?

A frame dependence

B overconfidence

C gambler's fallacy

4 The tendency for a decision maker to search for confirmation that a recent decision he or she made was a good decision represents which one of the following characteristics?

6 A general rule used as the basis for decision making is referred to as:

A a loss aversion technique

8 Old Country Productions requires skilled furniture finishers to put the final touches on all

of the furniture it produces The firm hired two individuals last year who had been students in

Mr Tedwell's wood shop class in high school Both of these employees have demonstrated exceptional skills and have already been promoted to senior finishing positions The firm currently has an opening for one additional finisher Tom, the head of the finishing section, has stipulated that he only wants to interview candidates who have completed Mr Tedwell's course Tom's behavior is typical of someone who has which one of the following

11 Which one of the following is an investment risk that investors face in addition to based risk and market-based risk?

firm-A management-related risk

B inflation risk

C supply chain risk

D interest rate risk

A overestimating the best outcome expected from a project while underestimating the

possibility of a less favorable outcome

B assuming that a new project will be profitable since similar projects in the past were successful

C assuming that your expectations of the future outcome from a project are more accurate than the expectations of others within your organization

D listening to the advice of subordinates with whom you agree while ignoring the advice of subordinates with whom you tend to disagree

E downplaying the cost of future failure of an existing project since the project has already paid for itself

15 Assume you are an overconfident manager You are most apt to do which one of the following more so than you would if you were not overconfident?

A research a project more thoroughly before committing funds to commence it

B accept risky projects that turn out to be less profitable than you expected

C wait until new technology proves its worth before incorporating it into your firm's

operations

D avoid mergers and acquisitions

E invest excess company cash more conservatively than your peers at other firms

16 Marzella Corp is analyzing a project that involves expanding the firm into a new product line The project includes the construction of a new manufacturing facility and also creating a new distribution system The project's financial projections will tend to have which one of the following characteristics if the person compiling those projections suffers from

overoptimism?

A over estimated construction costs

B over estimated expenses

C over estimated net present values

D under estimated profits

E under estimated sales estimates

17 When weighing a decision, Kate places greater emphasis on opinions that match her own than she does on opinions offered by others that disagree with her personal point of view Kate illustrates which one of the following?

18 Kaiser Marketing recently conducted a survey on behalf of Health Products The primary purpose of the survey was to illustrate to Health Products that it was relying on results of previous studies that, according to Kaiser, were unreliable due to the wording of the survey questions To prove this point, Kaiser conducted a two-prong survey In the first prong, the survey questions were worded such that the answers tended to sound positive In the second prong, the survey questions were re-worded such that the answers tended to convey a negativefeeling Both sets of survey questions should have resulted in similar results as the

information solicited was essentially identical However, the survey results varied

significantly This survey best illustrates which one of the following?

21 Steve purchased a stock last year for $34 a share The stock increased in value to $36 a share before declining to its current value of $30 Steve has decided to sell the stock but only

if he can receive $34 a share or better Steve is suffering most from which one of the

following behavioral conditions?

A overconfidence

B arbitrage theory

C the disposition effect

D the house money effect

E a confirmation bias

23 Over the past six months, you have watched as your parent's retirement savings have declined in value by 45 percent due to a severe financial market downturn As a result, you have decided that you will never invest in stocks for your own retirement but will instead keep all of your money in an insured bank account Which behavior characteristic have you developed as a result of the market downturn?

A myopic loss aversion

B get-evenitis

C self-attribution bias

D mental accounting

E regret aversion

24 Ramon opened a combination laundry and dry cleaning establishment three years ago Due to his excellent service and reasonable prices, his business has grown and is doing quite well financially He has considered expanding this business by opening another location but keeps putting off that decision for fear that the second location will not be a success Ramon iscurrently displaying which one of the following behavior characteristics?

$38,000 a year for 10 years Which one of the following behaviors applies to Phyllis?

A regret aversion

B money illusion

C self-attribution bias

D endowment effect

E myopic loss aversion

26 Kate is attempting to sell her house for $260,000 Fred lives across the street in an

identical house Fred recently stated to his wife that Kate's house is probably worth only

$250,000 but that once she sells her house, he would like to put their house on the market at

$285,000 and then move into a condominium Which one of the following behaviors applies

to Fred?

A myopic loss aversion

B house money effect

C money illusion

D self-attribution bias

E endowment effect

27 You recently overheard your boss telling someone that if he'd actually crunched some numbers and done some analysis instead of just going with his instincts that he never would have opened the new store in Centre City Which one of the following caused your boss to make a bad decision?

following applies to Roger?

29 Up until three years ago, A.C Dime opened an average of ten new retail stores a year One

of those stores had to be closed within two years due to poor sales This 90 percent success ratio was fairly steady for over 30 years Starting three years ago, the firm has opened 40 new stores and every one had significant profits within 6 months Management believes their recent success is not just a random event and that all future stores will be profitable Thus, the managers have decided to open a minimum of 15 new stores each year The managers are suffering from:

30 You are employed as a commission-based sales clerk for a cosmetics retail store You know that on average, exactly 50 percent of the customers that enter your store will make at least one purchase Thus far this morning, you have waited on eight customers without

making a single sale You are convinced that the next customer you wait on will buy

something This belief is known as:

A aversion to ambiguity

B the law of small numbers

C anchoring and adjusting

D gambler's fallacy

E false consensus

31 You don't particularly like to shop so only go to the mall once a month To help make the trek more enjoyable, you always have lunch at the restaurant located inside the mall Since you are such a creature of habit, you always order the same meal You've noticed that the price

of that meal has increased every time you have been there over the past six months Thus, youexpect the meal to increase in price next month This is an example of which one of the following?

A mental accounting

B anchoring and adjustment

C law of small numbers

D bubble and crash theory

E confirmation bias

33 You are a hard-charging manager who doesn't really like to sit at a desk for too long You prefer to gather information quickly, make a decision, and move on to the next item on your agenda Which one of the following applies to you?

36 Which of the following create limits to arbitrage?

I risks related to an individual firm

II implementation costs

III rational traders

IV noise traders

A I and III only

B II and IV only

C I, II, and III only

D I, II, and IV only

E I, II, III, and IV

37 AB Industries is an all-equity firm that has $8 per share in cash and a book value per share

of $12 At which one of the following market prices would you know with absolute certainty that the stock was mispriced?

I requirement for only a 10 percent cash payment to purchase a stock

II program trading

III irrational investors

IV preceeding bear market

A I and III only

B I and IV only

C II and III only

D I, II, and III only

E I, II, and IV only

39 Which one of the following statements related to market crashes is correct?

A Financial market crashes are unique to the United States

B A severe market decline tends to occur over a multi-day period

C Once the market finally crashed in 1929, stock prices began to slowly increase again

D The market crash of 1987 occurred on a day when trading volume was light indicating there were a limited number of irrational investors involved

E Actions in Washington, D.C may have helped contribute to the market crash in 1929 but not to the 1987 crash

40 Which one of the following statements is true?

A Market crashes tend to be accompanied by low market volume

B The Asian market crash was followed by a quick recovery

C The market crash of 1929 and the crash of 1987 are very similar in both the percentage decline in market value and in the ensuing market recovery

D Market crashes tend to follow market bubbles

E Market bubbles and crashes prove that financial markets are inefficient

41 Historical returns support which one of the following statements?

A Financial markets are highly inefficient as suggested by behavioral finance

B Professional money managers tend to outperform the Vanguard 500 index fund about 55 percent of the time on average

C The longer the time span, the more apt a professional money manager is to outperform an index fund, such as the S&P 500

D Historical data supports the statement that arbitrage is unlimited and results in a totally efficient market

E The financial markets appear to be efficient because, on average, they outperform

professional money managers

42 Which of the following statements are correct?

I Many professional fund managers are paid well but fail to outperform as expected

II Professional fund managers that have tenures in excess of ten years, tend to consistently outperform the market on a long-term basis

III If a market is truly efficient, then all investments in that market are zero net present value opportunities

IV Actively managing a fund appears to be the key to outperforming the market

A I and III only

B II and IV only

C II and III only

D I, II, and III only

E I, II, III, and IV

44 Explain 1) the concept of house money, 2) why the house money concept is such a common behavior for so many individuals and 3) why house money is an irrational behavior

45 Explain why a low-priced, low trading volume stock is more apt to present limits to arbitrage than is a high-priced, high trading volume stock

Chapter 22 Behavioral Finance: Implications for Financial Management Answer Key

Multiple Choice Questions

1 Amy is the chief financial officer of a retail toy store Recently, she decided that the firm should expand its operations and open two additional stores Within a very brief period, it wasobvious that Amy had made a very bad decision in opening those stores, given that the economy is in the middle of a severe recession In reflecting back on her decision, Amy realizes that she made a bad decision due to a reasoning error Which one of the following areas of study best applies to this situation?

2 Peter has successfully managed the finances of A.D Leadbetter in a manner that has yielded abnormally high returns Due to this success, Peter has decided to publish a newsletterfor financial executives so that he can share his superior financial wisdom with others There

is a very real probability that Peter has which one of the following characteristics?

4 The tendency for a decision maker to search for confirmation that a recent decision he or she made was a good decision represents which one of the following characteristics?

Topic: Confirmation bias

5 Which one of the following refers to the fact that an individual may reply differently if a question is asked in a different manner?

6 A general rule used as the basis for decision making is referred to as:

A a loss aversion technique

8 Old Country Productions requires skilled furniture finishers to put the final touches on all

of the furniture it produces The firm hired two individuals last year who had been students in

Mr Tedwell's wood shop class in high school Both of these employees have demonstrated exceptional skills and have already been promoted to senior finishing positions The firm currently has an opening for one additional finisher Tom, the head of the finishing section, has stipulated that he only wants to interview candidates who have completed Mr Tedwell's course Tom's behavior is typical of someone who has which one of the following

Topic: Representativeness heuristic

9 In an efficient market, it is believed by some individuals that the actions of traders who constantly buy and sell on any perceived market mispricings will in effect cause market prices

to correctly reflect asset values A person who believes that the actions of these traders will not result in correctly valued prices are most apt to believe in which one of the following?