Deck 9: Behavioural Finance and the Psychology of Investing

Question 1

Sentiment-based risk is __________ risk.

A) systematic
B) firm-specific
C) industry-specific
D) emotional-based
E) cost-based

Answer 1

D

Question 2

The price which is expected to be the minimal value for a security is called the:

A) base value.
B) par value.
C) reactive point.
D) resistance level.
E) support level.

Answer 2

E

Question 3

An unwillingness to take a risk after a loss describes:

A) over-confidence
B) the snakebite effect
C) the illusion of knowledge
D) the clustering illusion
E) loss aversion

Answer 3

B

Question 4

What is the area of finance called that addresses issues such as how reasoning errors affect investment decisions?

A) Logical
B) Economic
C) Behavioural
D) Rational
E) Personal

Question 5

Concluding that casual factors are at work behind random sequences is referred to as:

A) random seeking.
B) representativeness heuristic.
C) sequential processing.
D) randomness assumption.
E) random chance.

Question 6

Which one of the following best describes heuristics?

A) clustering
B) rules of thumb
C) grouping
D) representativeness
E) herding

Question 7

"__________" describes an investor who has a pessimistic market outlook.

A) Risk averse
B) Bear
C) Snakebitten
D) Overconfident
E) Fallacious gambler

Question 8

__________ finance is the area of study which addresses issues such as how reasoning errors affect

A) Logical
B) Economic
C) Behavioural
D) Rational
E) Personal

Question 9

The tendency for some individuals to believe that random events that occur in clusters are not really random is called the:

A) clustering illusion.
B) sequential delusion.
C) random grouping.
D) randomness rejection.
E) cluster effect.

Question 10

Dow theory is a method of predicting future market movements based on the Dow Jones __________ averages.

A) industrial and transportation
B) industrial and municipal
C) industrial and commodities
D) transportation and utilities
E) commodities and utilities

Question 11

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

A) the inability to acknowledge a financial loss.
B) selling any security for less than the price paid to acquire it.
C) selling a security as soon as it has earned a profit.
D) the hesitancy to sell a security after it has decreased in value.
E) the tendency to quickly dispose of any investment that has decreased in value.

Question 12

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

A) endowment effect
B) money illusion
C) regret aversion
D) myopic loss aversion
E) sunk cost fallacy

Question 13

The idea that rational, well-capitalized investors are not always able to immediately correct a market mispricing is referred to as:

A) a market limitation.
B) arbitrage trading.
C) market noise.
D) a daily flaw.
E) a limit to arbitrage.

Question 14

The theory which stresses the tendency of investors to react differently when faced with a potential loss versus a potential gain is called the _____ theory.

A) risk analysis
B) Relative
C) Behavioural
D) Personal
E) Prospect

Question 15

Technical analysis is the:

A) analysis of a firm's specific products and services to predict future growth.
B) review of a firm's financial statements to predict future earnings potential.
C) study of investor's emotional patterns to predict future market trends.
D) study of historical prices as a means of predicting future prices.
E) analysis of economic conditions to determine future market movements.

Question 16

When you compare the current price of a security to its purchase cost you are following a behavior known as:

A) gain recognition.
B) frame dependence.
C) time recognition.
D) dollar recognition.
E) mental accounting.

Question 17

An investor who trades without good information or any worthwhile financial analysis is referred as a(n):

A) arbiter.
B) market timer.
C) noise trader.
D) sentiment trader.
E) market maker.

Question 18

The tendency of individuals to react differently to the same situation based on how the situation is presented is referred to as:

A) frame dependence.
B) loss analysis.
C) prospect theory.
D) mental accounting.
E) behavioral responsiveness.

Question 19

The Elliott wave theory is a theory used to predict future market movements based on:

A) repetitive trading patterns over an 8-week period.
B) the tidal waves created by the gravitational pull of the moon.
C) eight sequential pricing patterns.
D) the life-cycle of an industry.
E) market trends which come and go over time.

Question 20

Loss aversion is defined as:

A) sell stocks with gains more frequently than stocks with losses
B) sell stocks with losses more frequently than stocks with gains
C) hold stocks with gains and sell stocks with losses
D) sell all stocks after a pre-determined length of time
E) hold all stocks unless they decline more than ten percent in value

Question 21

For the financial markets to be inefficient,:

A) arbitrage trading must be prohibited.
B) the collective irrational trading of some investors must exceed the corrective arbitrage trading of the remaining investors.
C) at least the majority of the investors must be overly optimistic.
D) each irrational investor must act independently of every other irrational investor.
E) irrational investors must become arbitrage traders.

Question 22

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:

A) myopic loss aversion.
B) frame dependence.
C) regret aversion.
D) risk-taking.
E) mental accounting.

Question 23

Individual investors tend to:

A) quickly sell their losers and buy more of their winners.
B) sell their losers and hold their winners.
C) sell winners more frequently than losers.
D) sell winners and losers with equal frequency.
E) suffer from loss aversion while professional money managers do not.

Question 24

A continuation pattern is a pattern where

A) the primary and the secondary trend signal the same movement.
B) the upper and lower Bollinger bands maintain a distance of 4 standard deviations apart.
C) the 12-day and 26-day moving averages converge.
D) the head-and-shoulders pattern indicates a false breakout.
E) the price of a stock is expected to continue along its main direction.

Question 25

Mental accounting tends to lead to irrational investor behavior because it supports the notion that:

A) investors tend to overanalyze each investment opportunity.
B) investors avoid any mental effort related to investing.
C) selling a security is mentally easier than purchasing it.
D) investors can become emotionally attached to a security at a specific value.
E) investors have unrealistic rate of return expectations.

Question 26

Investors react stronger to a financial __________ than they do to a financial __________, according to prospect theory.

A) profit; loss
B) loss; profit
C) purchase; sale
D) sale; purchase
E) debt security; equity security

Question 27

An interesting observation about Fibonacci numbers is

A) the frequency with which they appear in nature.
B) their predictive ability.
C) the fact that they are all even.
D) the fact that they are all odd.
E) their superstition.

Question 28

Peg is a contestant on a game show. At this point in the game, she can either accept $1,000 or she can throw one dart at a game board for a chance of winning $500,000. If Peg accepts the guaranteed $1,000, she is displaying __________ behavior.

A) optimistic
B) risk-adverse
C) prospective
D) risk-neutral
E) risk-taking

Question 29

A relative strength chart compares the:

A) number of buy orders to the number of sell orders.
B) volume of trading for one day to another day.
C) performance of one security or market to another.
D) value of one investor's performance to that of another investor.
E) gains and losses for a particular investment.

Question 30

Lester purchased a stock which has declined in value by 25 percent due to production flaws and obsolete product offerings. Lester continues to purchase shares as the stock price continues to decline. Lester is displaying the characteristic known as:

A) endowment effect.
B) money illusion.
C) regret aversion.
D) myopic loss aversion.
E) sunk cost fallacy.

Question 31

The number of shares in an "odd lot" is:

A) less than 100 shares.
B) 100 shares.
C) greater than 100 shares.
D) less than the daily average block trade.
E) any numbers of shares ending in an odd number.

Question 32

If you suffer from money illusion, you:

A) are obsessed with earning high returns and gathering great wealth.
B) believe that your meager savings will support your retirement even though that is totally unrealistic.
C) do not understand the difference between nominal and real buying power.
D) refuse to recognize that you have incurred losses which will probably not be offset for an extended period of time.
E) believe that everyone else has more money than you do, even though that is untrue.

Question 33

Martha refuses to invest her retirement money in stocks or bonds as she is afraid that if she does, she will lose money this year. Martha is displaying a characteristic known as:

A) frame dependence.
B) regret aversion.
C) mental accounting.
D) house money.
E) myopic loss aversion.

Question 34

The maximum value which the market is expected to reach is called the:

A) whole value.
B) target value.
C) reactive point.
D) resistance level.
E) support level.

Question 35

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

A) sell stocks with gains more frequently than stocks with losses
B) sell stocks with losses more frequently than stocks with gains
C) hold stocks with gains and sell stocks with losses
D) sell all stocks after a pre-determined length of time
E) hold all stocks unless they decline more than ten percent in value

Question 36

A year ago you bought two stocks. You bought Sid Corp. for $40 per share and Ovie Enterprises for $5 per share. Today they are BOTH worth $20. If you suffer from loss aversion you might:

A) keep the shares of Sid Corp and sell the shares of Ovie Enterprises.
B) keep the shares of Ovie Enterprises and sell the shares of Sid Corp.
C) hold the shares of both.
D) sell the shares of both.
E) Sell or buy based on your rational analysis.

Question 37

Investors tend to make better decisions if they concentrate on:

A) actual losses only.
B) only potential losses.
C) individual securities.
D) the overall situation.
E) potential profits only.

Question 38

The term house money refers to the concept that investors react differently to:

A) losing their profits as compared to losing their initial investment.
B) losing their savings to buy a home as compared to their other savings.
C) losses than they do to gains.
D) money they manage individually versus the money they have placed under the control of a professional money manager.
E) money that is jointly owned with a spouse than that which is their personal asset.

Question 39

Last week, Alicia stated that ABC stock was only worth $16 a share and since it was selling for $23 a share, she declared it overpriced refusing to buy. After inheriting 1,000 shares of ABC stock from her grandmother, Alicia is suddenly saying that ABC stock is a great buy at $23 and is probably worth at least $31 a share. This is an example of the:

A) endowment effect.
B) money illusion.
C) regret aversion.
D) myopic loss aversion.
E) sunk cost fallacy.

Question 40

According to prospect theory, investors:

A) tend to always be risk-adverse.
B) tend to always be risk-taking.
C) are risk-taking when it comes to losses.
D) are risk-adverse when it comes to losses.
E) tend to risk-neutral.

Question 41

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

A) -1
B) 0
C) 1
D) 50
E) 100

Question 42

According to Dow theory, the long-run direction of the stock market is seen in the:

A) daily market movements.
B) secondary reaction.
C) MSI trend.
D) primary trend.
E) tertiary trend.

Question 43

If all investors are bullish, the market sentiment index (MSI) will have a value of:

A) 0
B) -1
C) 1
D) 50
E) 100

Question 44

The Dow theory:

A) proposes that the market is bullish only when the secondary trends are bearish.
B) advocates that the market rarely deviates from its primary trend for more than 2 weeks.
C) states that daily market movements are key to changes in the overall market trend.
D) supports the idea that primary trends are eliminated by corrections.
E) is primarily designed to identify changes in the primary market direction.

Question 45

Which of the following are considered limits to arbitrage?
I) sentiment-based risk
II) systematic risk
III) firm-specific risk
IV) noise trader risk

A) I and III only
B) II and IV only
C) I, III, and IV only
D) II, III, and IV only
E) I, II, III, and IV

Question 46

Which one of the following market sentiment index (MSI) values represents the best selling opportunity to the contrarian investor?

A) 0.16
B) 0.29
C) 0.48
D) 0.61
E) 0.82

Question 47

Which one of the following is considered the best indicator of a bull market according to

A) a breakout of a resistance level
B) a breakout of a support level
C) market prices remaining above the support level
D) prices falling below the support level
E) prices remaining between the resistance and support levels

Question 48

The Dow theory describes stock prices are moving in trends analogous to the movement of water. Which of the following is incorrect?

A) major trends resemble tides.
B) intermediate trends resemble waves.
C) short-run movements are like ripples.
D) waves are the most important.
E) none of the above.

Question 49

If you prefer to buy stocks at prices which are considered relatively low, you should buy a stock when its price:

A) breaks through the resistance level.
B) is just short of the resistance level.
C) approaches the support level, given than you expect the price to rebound.
D) exceeds the support level by a relatively good margin.
E) is relatively in the middle between the resistance and the support prices.

Question 50

If you are a proponent of the Elliott wave theory, you:

A) buy based on the primary trend and sell based on the secondary trend.
B) will buy at the beginning and sell at the end of the impulsive waves.
C) have the ability to determine when to buy, but not when to sell.
D) will buy on wave #3 and sell on wave #8.
E) expect all market corrections to occur in one swift wave.

Question 51

Investor overconfidence tends to cause investors to: I. trade too frequently.
II) invest too heavily in the securities issued by their employer.
III) earn lower rates of return caused by trading frequency.
IV) invest too heavily in companies from their local region.

A) I and III only
B) II and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV

Question 52

According to the idea of "hot-hand" fallacy, investors are most apt to:

A) quickly sell any loser.
B) invest most heavily in their big losers.
C) get in and back out of the market quickly.
D) invest more in recent winners than in recent losers.
E) sell their winners and keep their losers.

Question 53

Five of the last 6 stocks your investment adviser recommended have outperformed the market. You therefore believe that your adviser will be right 5 out of every 6 times. This belief is based on the:

A) gambler's fallacy.
B) law of small numbers.
C) law of large numbers.
D) clustering illusion.
E) positive performance illusion.

Question 54

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

A) revolve around their long-term average performance.
B) react over the next year in direct opposition to the performance of the prior year.
C) have a maximum of 4 years of positive annual returns.
D) continue to perform as they have over the past couple of years.
E) have an average return for the next 3 years that equals the average return for the past 30 years.

Question 55

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

A) 0.16
B) 0.29
C) 0.48
D) 0.61
E) 0.82

Question 56

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

A) believing what you wish to believe
B) placing too much weight on information which you can gather easily
C) believing that other investors agree with your thinking
D) taking credit for the wins and blaming the losses on bad luck
E) believing that your recent performance is an indication of your future performance

Question 57

Firm-specific risk can create a barrier to arbitrage when

A) securities are poor substitutes for one another
B) securities have weak correlations
C) security market is illiquid
D) security market is segmented
E) none of the above

Question 58

Mark feels that gold will increase in value significantly this coming year simply because it has lost value in each of the last five years. Mark is displaying signs of the:

A) clustering illusion.
B) house money effect.
C) gambler's fallacy.
D) endowment effect.
E) loser's turnaround.

Question 59

The fact that the money managers that earned the best returns last year tend to attract more money this year than the average money manager is an example of:

A) the money effect.
B) the clustering illusion.
C) the endowment effect.
D) the house money effect.
E) overconfidence.

Question 60

If all investors are bearish, the market sentiment index (MSI) will have a value of:

A) 0
B) -1
C) 1
D) 50
E) 100

Question 61

A 5-day exponential moving average:

A) is a compound function.
B) places more emphasis on the latest closing price than it does on prior 4 day's closing prices.
C) considers only the prior day's closing price.
D) places a weight of 20 percent on the closing price of each day.
E) is an indicator of the long-term trend of the market.

Question 62

Technicians believe that a stock that is outperforming the market will tend to:

A) form head and shoulder patterns.
B) meet a resistance level.
C) reverse trend.
D) return to normal.
E) continue to outperform the market.

Question 63

An increase in the relative strength value from 1.06 to 1.09 indicates that:

A) one security is continuing to outperform the other security.
B) at least one of the securities is outperforming the overall market.
C) one security is increasing in value while the other is decreasing in value.
D) both securities are increasing in value.
E) both securities are decreasing in value.

Question 64

Which one of the following Arms values is the most bullish?

A) .67
B) .75
C) 1.00
D) 1.06
E) 1.23

Question 65

Which of the following market indicators is based on the idea of "contrary opinion"?

A) volume data.
B) confidence index.
C) odd-lot index.
D) liquidity of mutual funds.
E) advance-decline line.

Question 66

Which two of the following are possible explanations for the situation where a 30-day moving average intersects a 300-day moving average assuming that the 30-day average is upward sloping and the 300-day average in downward sloping?
I) the long-term trend of the market is getting ready to turn bullish
II) the long-term trend of the market is getting ready to turn bearish
III) the market will be bullish in the short-run but bearish in the long-run
IV) the market will be bearish in the short-run but bullish in the long-run

A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) None of the above

Question 67

Which of the following have been used as bullish market indicators?
I) short skirts
II) negative money flow with stable stock price
III) a win by an NFL team
IV) a piercing of the neckline support

A) I and III only
B) II and IV only
C) III and IV only
D) I, II, and III only
E) II, III, and IV only

Question 68

Money flow measures the:

A) total dollar volume of trading on a daily basis.
B) total dollar value of all securities listed on an exchange.
C) strength of the buying versus the selling of a security.
D) volume of trading in a particular security on a given trading day.
E) total increase or decrease in the value of a security on a daily basis.

Question 69

According to technical analysts, pricing patterns such as the head and shoulders pattern, are indicators of:

A) reversals from the main trend line.
B) upcoming corrections which will return the market to the current main trend line.
C) increasing strength for the main trend line.
D) decreasing market activity.
E) increasing market activity.

Question 70

Bollinger bands:

A) depict the convergence or divergence of two moving averages.
B) display the relative strength of one market sector versus another.
C) are a graphical representation of an exponential moving average.
D) are based on 2 standard deviations around a moving average.
E) are the current support and resistance levels for the overall market.

Question 71

If the closing tick of the day is +724, this means that the:

A) DJIA ended the day up 724 basis points.
B) discount rate at the end of the day was 7.24 percent.
C) number of stocks closing on an uptick was 724.
D) number of stocks closing on an uptick exceeded those closing on a downtick by 724.
E) number of stocks closing on an uptick was 724 more than on the prior trading day.

Question 72

Advances and declines are associated with market

A) efficiency
B) position
C) diffusion
D) depth
E) breath

Question 73

Some technical analysts use Fibonacci numbers to predict:

A) primary trend breakthroughs.
B) market turnarounds.
C) secondary market trend lines.
D) relative performance values.
E) resistance and support levels.

Question 74

Fibonacci numbers are:

A) numbers which never seem to appear in the natural world.
B) commonly referred to as the silver series.
C) created by multiplying the 2 previous numbers in the series and then taking the square root of that value.
D) numbers such that phi is roughly equal to .382.
E) a series of numbers wherein each number, starting with the third number in the series, is equal to the summation of the two previous numbers.

Question 75

If a stock's price remains relatively stable while the money flow becomes quite positive, you should expect the __________ according to technical analysts.

A) stock price to decrease
B) stock price to remain relatively stable
C) stock price to increase
D) trading volume to increase
E) trading volume to decrease

Question 76

If you are an advocate of the odd-lot indicator, you will buy stocks when:

A) odd-lot trading volume decreases significantly.
B) the odd-lot traders are primarily selling.
C) the odd-lot traders significantly increase their buying.
D) odd-lot trading volume remains relatively flat.
E) the odd-lot traders appear to be overly optimistic.

Question 77

A resistance level differs from a support level in that

A) at a resistance level most investors would hold stock until the price improves; at a support level a stock becomes overvalued and investor interest is likely to decrease.
B) at a resistance level the analyst would expect a substantial increase in the demand for a stock; at a support level the analyst would expect a substantial decrease in the demand for a stock.
C) at a resistance level most investor would sell a stock; at a support level most investors would be willing to purchase a stock.
D) at a resistance level, the technician would expect to an increase in demand for a stock.
E) none of the above.

Question 78

On a graph depicting a head and shoulders top pattern, the neckline support:

A) indicates a bull market when it is pierced.
B) is the trend line that existed prior to the head and shoulders pattern appearing.
C) is a straight line connecting the high points of the left and right shoulders.
D) indicates a reversal signal anytime it is broken through in a downward direction.
E) is a line drawn connecting the humps created by the left and right shoulders.

Question 79

On an open-high-low-close chart, the price channel is:

A) bounded on the lower level by the opening price for each trading day.
B) a linear function with points set at the closing price of each trading day.
C) bounded by the daily opening and closing prices.
D) bounded by both an upper and a lower trend line.
E) a graph of the difference between a day's high and low price.

Question 80

If the advance/decline line is __________ the markets are considered to be the most bearish.

A) relatively flat
B) slightly upward sloping
C) slightly downward sloping
D) steeply upward sloping
E) steeply downward sloping