Question 1

Which one of the following market sentiment index (MSI)values represents the best buying opportunity?

Accepted Answer

The answer of Which one of the following market sentiment...

Question 2

Yesterday, Krista stated that Overland stock was only worth $12 a share and since it was selling for $15 a share, she declared it overpriced and refused to buy any shares. This morning, she learned that she is inheriting 3,500 shares of Overland stock from her grandmother. Suddenly, she is saying that Overland stock is a great buy at $15 and is probably worth at least $17 a share. This is an example of which one of the following?

Accepted Answer

The endowment effect is the tendency to overvalue something simply because we own it. In this case, Krista did not want to buy Overland stock at $15 because she believed it was overpriced, but now that she is inheriting it, she sees it as a great buy at that price. Her perception of the stock's value has shifted simply because she now owns it.

Question 3

Investors tend to make better decisions when looking at a decision:

Accepted Answer

Looking at decisions in broad terms allows investors to consider a variety of factors such as market trends, macroeconomic conditions, and potential risks and opportunities. This helps investors to make more informed and well-rounded decisions, rather than solely focusing on one aspect such as historical performance or potential losses.

Question 4

Which one of the following is an example of mental accounting?

Accepted Answer

Mental accounting is the tendency for people to mentally compartmentalize money into different categories based on arbitrary criteria. Associating a security's gains or losses based on its purchase price is an example of mental accounting because it is not necessarily relevant to the current value or performance of the security, but rather a past decision.

Question 5

According to the concept of loss aversion, individual investors are most apt to do which one of the following?

Accepted Answer

Loss aversion is a concept in behavioral finance suggesting that individuals prefer avoiding losses to acquiring equivalent gains. It leads investors to hold onto stocks that have lost value, hoping they will rebound, while selling those that have gained value to "lock in" the gains, thus selling stocks with gains more frequently than those with losses.

Question 6

Which one of the following is a characteristic of the self-attribution bias?

Accepted Answer

The self-attribution bias is the tendency to take credit for our successes and attribute our failures to external factors, such as bad luck or other people's actions. Therefore, D is the characteristic that best describes this bias.

Question 7

Which one of the following statements appears to be correct based on current research?

Accepted Answer

Current research shows that overconfidence tends to result in lower investment returns. A, C, D, and E are incorrect based on current research.

Question 8

Which one of the following indicates the long-run direction of the market according to Dow Theory?

Accepted Answer

According to Dow Theory, the primary trend indicates the long-run direction of the market, which can last for several years. The daily fluctuations, secondary reactions, and tertiary trends are shorter-term movements that can occur within the primary trend. Monthly changes may be influenced by both short-term and long-term factors, but they do not necessarily reflect the overall direction of the market in the long run.

Question 9

According to the theory of recency bias, investors tend to believe the financial markets will:

Accepted Answer

The theory of recency bias suggests that investors believe financial markets will continue to perform as they have over the past few years, leading to the belief that recent trends will continue indefinitely. Therefore, the most appropriate answer would be D.

Question 10

Tricia has lost money on a particular stock for the past three years. Thus, she believes the stock will have a high positive rate of return this year because earning a good return is long overdue. This assumption is best described as the:

Accepted Answer

The assumption that the stock will have a positive rate of return this year because it is long overdue is an example of the gambler's fallacy, which is the mistaken belief that future probabilities are altered by past events that are unrelated to them. Just because the stock has lost money for the past three years does not necessarily mean it will have a positive return this year. This is similar to the misconception that if a coin has landed on heads multiple times in a row, it is more likely to land on tails on the next flip.

Question 11

Which one of the following market sentiment index (MSI)values indicates that all polled investors were bearish?

Accepted Answer

The answer of Which one of the following market sentiment...

Question 12

Peter hesitates when it comes to picking an individual stock to purchase as he feels that he will later realize that a different stock would have been a better investment. Peter is suffering from:

Accepted Answer

Regret aversion is a cognitive bias where individuals avoid making decisions that they fear will lead to regret. Peter's fear of picking the wrong stock and later regretting it is a clear example of regret aversion.

Question 13

Ted constantly ignores the effects of inflation on money. Ted is suffering from which one of the following?

Accepted Answer

Ted is suffering from money illusion, which is a cognitive bias where individuals disregard the effects of inflation on the value of money. They might believe that a certain amount of money has a fixed value, regardless of inflation.

Question 14

According to the concept of house money, individual investors are most apt to do which one of the following?

Accepted Answer

According to the concept of house money, people tend to value gains and losses differently depending upon the source of the money. In other words, they may take greater risks with money that they perceive as "house money" (e.g. money they won at the casino or through a lucky stock pick) than with money that they perceive as their own. This is known as the "house money effect." Therefore, option B is the best choice. The other options do not accurately describe the concept of house money.

Question 15

Patrick is a contestant on a game show. At this point in the game, he can either accept $500 or spin a wheel for a chance to win $100,000. Which type of behavior is he displaying if he spins the wheel?

Accepted Answer

Patrick is displaying risk-taking behavior by choosing to spin the wheel for a chance to win $100,000 instead of accepting the guaranteed $500.

Question 16

The increased cash flows into mutual funds that have recently had superior returns is most associated with which one of the following characteristics?

Accepted Answer

The answer of The increased cash flows into mutual funds...

Question 17

The tendency to overvalue an item because you own it is referred to as which one of the following?

Accepted Answer

The overvaluation of an item because one owns it is known as the endowment effect. This biases individuals to demand a higher price to sell the item than they would be willing to pay to acquire the same item, leading to the perception of an irrational attachment to the item.

Question 18

Investors who tend to invest too heavily in the securities issued by their employer suffer from the condition known as:

Accepted Answer

Investing heavily in securities issued by one's employer is a risky behavior that suggests overconfidence in the company's future prospects. Overconfidence is the tendency to believe that one's skills, abilities, or judgments are better than they actually are, which can lead to poor decision-making and investment mistakes.

Question 19

Which of the following are impediments to the correction of a security's mispricing?
I. sentiment-based risk
II. implementation costs
III. firm-specific risk
IV. noise trader risk

Accepted Answer

Sentiment-based risk, implementation costs, firm-specific risk, and noise trader risk can all impede the correction of a security's mispricing. Sentiment-based risk and noise trader risk can lead to irrational trading behaviors that distort prices. Implementation costs can make it financially unviable to exploit mispricings. Firm-specific risk can deter arbitrageurs due to the unpredictability of returns related to specific companies.

Question 20

Four of the last five stocks your investment adviser recommended have outperformed the market. Thus, you believe that if you continue to follow her advice, 80 percent of your investments will outperform the market over the long term. This belief is based on the:

Accepted Answer

The belief that 80 percent of investments will outperform the market over the long term based on the adviser's recent recommendations is an example of the law of small numbers, which assumes that a small sample will reflect the characteristics of the larger group it is drawn from. However, this assumption may not hold true over the long term, as chance plays a larger role in smaller samples. Therefore, it is important to be cautious when making investment decisions based on a small number of past successes.

Quiz 8: Behavioral Finance and the Psychology of Investing

Which one of the following market sentiment index (MSI) values represents the best buying opportunity?