Reading The Behavioral Finance Perspective FinQuiz.com FinQuiz.com CFA Level III Item-set - Question Study Session June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz.com FinQuiz Item-set ID: 67408 Questions 1(67409) through 6(67414) relate to Reading Keith Bryant Case Scenario Keith Bryant is a senior portfolio manager at Boston Investment Management (BIM), an investment advisory firm with a number of branches throughout the U.S Bryant works for the investment wing that targets high net worth private wealth clients Recently, Bryant gathered his portfolio management team for a discussion on behavioral finance concepts and their implications for investment management During the discussion, Bryant quoted the following comments made by some of his clients over his ten-year portfolio management experience: Client A: “I would like you to consider my risk tolerance before constructing a portfolio for me To be more specific, I not want to invest in a portfolio that has an overall volatility of more than 15% In addition, I want you to maximize the returns given this risk constraint, and also to maintain a 10% allocation to cash regardless of my income level.” Client B: “I believe that taking excessive risk with investments does not necessarily yield high returns in the long-run Hence, I would not want to invest in any portfolio that has an expected return less two standard deviations of less than -5.0% I would also not like to invest in emerging market stocks unless they have a correlation of -0.45, or less, with my portfolio.” Client C: “I would like you to consider my entire net worth, and then to classify my sources of wealth into current income and current assets I would want to use my current income to meet my current living expenses and to save in order to increase my current assets This will ensure that I have enough savings for meeting my longterm goals.” Client D: “I am glad that my employer offers a defined contribution pension plan where it matches any contributions that I make Every year, I try to deposit 20% of my annual salary along with any extra compensation I receive in the plan to make sure I am saving for the future instead of using it all up.” Client E: “My previous portfolio manager determined asset prices based on a detailed calculation of fundamental risk factors For each asset, he determined a discount rate that captured all fundamental risk premiums corresponding to the asset However, I believe that the discount rate he used underestimated the true risks of the assets.” Client F: “I want to maximize expected wealth subject to the constraint that the probability of my wealth being less than the needed level should not exceed 5.0%.” FinQuiz.com © 2018 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz.com FinQuiz Question ID: 67409 Client A will most likely agree with which of the following assumptions? A Investors and their advisors have perfect information and behave rationally B Investors are not risk-averse but rather are loss-averse C Investors have a self-control bias where they focus on short-term satisfaction instead of pursuing long-term goals FinQuiz Question ID: 67410 The portfolio construction decisions of Client B are most consistent with the: A prospect theory B traditional finance theory C behavioral life-cycle theory FinQuiz Question ID: 67411 Client C least likely exhibits a: A self-control bias B framing bias C sentiment risk bias FinQuiz Question ID: 67412 Client D’s portfolio construction process will most likely be consistent with the: A behavioral life-cycle theory B behavioral portfolio theory C behavioral SDF-based asset pricing theory FinQuiz Question ID: 67413 Client E’s approach to asset pricing is most likely consistent with the belief that: A asset prices are inefficient B analysts’ forecasts of an asset’s price are highly correlated C traditional finance fails to result in the selection of wealth-maximizing or optimal portfolios FinQuiz Question ID: 67414 Client F most likely constructs portfolios according to the: A behavioral life-cycle theory B behavioral portfolio theory C traditional finance theory FinQuiz.com © 2018 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz.com FinQuiz Item-set ID: 67419 Questions 1(67420) through 6(67425) relate to Reading Analytical Investment Associates (AIA) Case Scenario Analytical Investment Associates (AIA) is a U.S based asset management firm that specializes in traditional stock and bond investments, as well as in alternative investments including real estate, private equity and hedge funds Pamela Cameron is the chief portfolio manager at AIA who heads a team of seven portfolio managers Due to the emerging emphasis on the application of behavioral finance concepts to investment decisions, Cameron headed a meeting with her portfolio management team for a discussion on behavioral finance During the meeting she made the following comment: Statement 1: “The behavior of market participants is not necessarily rational Individuals, at times, identify with satisfactory sub-goals rather than try to achieve an optimum, and then make decisions to meet these limited objectives In addition, as experience increases, individuals learn and apply new heuristics to changing situations.” Cameron then presented the following investor comments to explain how individuals actually make portfolio construction decisions: Investor A: “I construct my portfolio in layers by considering the variance of individual assets and the covariance among the layers Also, my expectations of return and risk attitudes vary between the layers.” Investor B: “I always hold large amounts of cash so that I not have to meet liquidity needs by selling assets In addition, I generally hold underperforming security positions for a considerable time, since I believe that a stock always has an ability to rebound.” Investor C: “To take my risk attitudes into account, I always advice my portfolio manager to limit the risk of failing to achieve my aspirational level of wealth.” After the meeting, Michelle Baines, one of the portfolio managers, approached Cameron to talk about behavioral finance alternatives to the efficient market hypothesis and Markowitz’s portfolio theory Cameron made the following comments: Statement 2: “The efficient market hypothesis (EMH) assumes that individuals are risk averse, self-interested and completely rational Under the adaptive market hypothesis (AMH), individuals not act in their own self-interest, use heuristics, make mistakes and learn from them.” FinQuiz.com © 2018 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz.com Statement 3: “The behavioral portfolio theory (BPT) assumes that investors are not risk averse but rather loss-averse The Markowitz portfolio theory assumes that investors are risk-averse.” Cameron manages a $5 million portfolio for Dana Hart, one of her oldest clients Hart wants to make $5,200,000 and has stated a probability of not meeting this wealth level equal to 30% Also, Hart has decided that she cannot tolerate the portfolio value declining below 4.5 million dollars Cameron has constructed a portfolio for Hart that is allocated 60% to riskless assets, 20% to risky assets, and 20% to highly speculative assets The portfolio is expected to return 3.9% about 65% of the time, and it has a 0% probability of falling below $4.5 million Cameron has invested 5% of her portfolio in the Brazilian stock market As part of her analysis of the market, Cameron is trying to determine if stock prices move too much to be justified by subsequent changes in dividends She is also studying Brazilian capital market seasonality FinQuiz Question ID: 67420 Which of the following behavioral concepts best captures the behavior of individuals as identified by Cameron in Statement 1? A Prospect theory B Bounded rationality C AMH FinQuiz Question ID: 67421 Which of the investor comments presented by Cameron are most likely consistent with the BPT? A Comments by Investors A and B only B Comments by Investors B and C only C Comments by Investors A, B and C FinQuiz Question ID: 67422 Cameron is most accurate with respect to: A Statement only B both statements and C neither Statement nor Statement FinQuiz Question ID: 67423 10 Given Hart’s objectives, which of the following about her portfolio is most accurate? A The portfolio’s safety level objective needs to be lowered B The portfolio’s allocation to riskless assets should be increased C The portfolio appropriately meets the aspirational goals and safety objective FinQuiz.com © 2018 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz.com FinQuiz Question ID: 67424 11 With respect to the Brazilian market, Cameron is most likely trying to identify: A calendar and technical anomalies B calendar and fundamental anomalies C fundamental and technical anomalies FinQuiz Question ID: 67425 12 Which of the following least likely incorporates the concept of bounded rationality? A Decision theory B BPT C AMH FinQuiz.com © 2018 - All rights reserved ... finance theory FinQuiz. com © 20 18 - All rights reserved Reading The Behavioral Finance Perspective FinQuiz. com FinQuiz Item- set ID: 67419 Questions 1(67 420 ) through 6(67 4 25 ) relate to Reading Analytical.. .Reading The Behavioral Finance Perspective FinQuiz. com FinQuiz Item- set ID: 67408 Questions 1(67409) through 6(67414) relate to Reading Keith Bryant Case Scenario... declining below 4 .5 million dollars Cameron has constructed a portfolio for Hart that is allocated 60% to riskless assets, 20 % to risky assets, and 20 % to highly speculative assets The portfolio