CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 02 behavioral finance questions

BEHAVIORAL FINANCE QUESTION HAS ONE PART FOR A TOTAL OF MINUTES Samnang Kahn works for World Financial Management (WFM) as a portfolio manager for individual investors Kahn is preparing for the yearly review of several of his clients with the first one being Kenneth Clark Clark is in his early 50s, divorced with two children, and has a total net worth of approximately $500,000 Clark works as an electrical engineer and also has an MBA He has been investing for some time on his own When he first started investing, he thought his MBA gave him the expert knowledge needed to be a proficient investor After several years of mediocre performance of his investments, he realized he should get some professional help This led to his relationship with Kahn One of Clark’s stocks is called X-wire, which Clark is familiar with from working in the engineering field Historically, X-wire has performed well and this led Clark to believe it would continue to so in the future After buying the X-wire stock it continued to well for a short period of time and then decreased in price below Clark’s original purchase price Clark is reluctant to sell it in hopes of at least breaking even in the near future For each statement in the template provided below, state the most likely behavioral bias Clark is exhibiting from the following choices: loss aversion, overconfidence, myopic loss aversion, representative bias, or fear of regret Use any behavioral bias only once Explain one consequence of the behavior from a portfolio perspective (9 minutes) Statement State the most likely behavioral bias being exhibited Explain one consequence of the behavior from a portfolio perspective When he first started investing, he thought his MBA gave him the expert knowledge needed to be a proficient investor Historically, X-wire has performed well and this led Clark to believe it would continue to so in the future After buying the X-wire stock it continued to well for a short period of time and then decreased in price below Clark’s original purchase price Clark is reluctant to sell it in hopes of at least breaking even in the near future QUESTION HAS TWO PARTS (A, B) FOR A TOTAL OF MINUTES Michelle King is thinking about making changes to her defined contribution plan When King started making contributions into her plan she left her investments alone for several years, maintaining the same asset allocation as she originally started with Because of this unsuccessful strategy, King then diversified equally among all the different investment options available to her in her plan Over time, King has become more knowledgeable about investing and realized she needs to determine what her level of risk aversion is and allocate her portfolio accordingly, taking into consideration the number of years until she retires A Identify and describe two behavioral traits King displayed while investing in her defined contribution plan (4 minutes) B State one advantage and one disadvantage of the pyramid structure as an investment strategy for individual investors (4 minutes) QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 15 MINUTES Peter Dangforth is a new CFA charterholder with big plans to convince his partners that behavioral finance concepts can increase profitability for their investment management business He tells them the following:    Traditional finance is descriptive of how investors actually invest their money It assumes markets are efficient and allows the manager to focus on asset allocation rather than identification of misvalued securities Behavioral finance assumes investors have greater decision-making ability and are risk seekers Traditional finance is based on utility theory while behavioral finance assumes that, in some cases, prospect theory and loss aversion are more useful in understanding clients A For each of the first two statements made by Dangforth, identify one thing that is incorrect and restate each statement in a way that is correct (4 minutes) B Regarding Dangforth’s third statement, explain two ways that utility theory and loss aversion differ (4 minutes) Later in the week, Dangforth has two meetings First is a meeting with a longtime client of the firm but a new client for Dangforth His coworkers warn him that the client is very demanding and regularly brings up the time his former manager was heavily invested in technology stocks, right before the technology stock price bubble burst Second is the monthly Investment Policy Committee meeting for the firm Dangforth finds the meetings unproductive Key issues are not discussed, trivial issues drag on, and people forget what has already been decided He really wishes this could change He is particularly frustrated because, as individuals, each committee member is well qualified, and collectively, the committee has all the skills needed C Identify one contributing factor that behavioral finance suggests can explain market bubbles, and explain how that factor can contribute to markets becoming overvalued (3 minutes) D Explain why behavioral factors can be a greater impediment to effective investment decision making for investment committees than for individual committee members, and state two actions the committee chairman can implement to improve the effectiveness of this firm’s committee (4 minutes) ... misvalued securities Behavioral finance assumes investors have greater decision-making ability and are risk seekers Traditional finance is based on utility theory while behavioral finance assumes... investors (4 minutes) QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 15 MINUTES Peter Dangforth is a new CFA charterholder with big plans to convince his partners that behavioral finance concepts... contributing factor that behavioral finance suggests can explain market bubbles, and explain how that factor can contribute to markets becoming overvalued (3 minutes) D Explain why behavioral factors