Question 1

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 2

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

Accepted Answer

According to Dow theory, the primary trend is the most important and long-term trend in the stock market. The primary trend defines the main direction of the market for an extended period, typically lasting one to several years. The daily market movements (option A), secondary reaction (option B), MSI trend (option C), and tertiary trend (option E) are all short-term or intermediate trends that have less significance than the primary trend.

Question 3

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

Accepted Answer

The answer of If all investors are bullish, the market...

Question 4

The Dow theory:

Accepted Answer

The Dow theory is primarily designed to identify changes in the primary market direction, making option E the correct answer. Option A is incorrect as the Dow theory suggests that when the secondary trends are bullish, the market is in a bullish phase. Option B is incorrect as the Dow theory proposes that the primary trend remains consistent for a more extended period, and temporary fluctuations may occur in weeks, months, or longer. Option C is incorrect as daily market movements are insignificant in the Dow theory, and the focus is on broader trends. Option D is incorrect as corrections are a natural part of the market cycle, and the primary trend is not eliminated by them.

Question 5

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

Accepted Answer

Limits to arbitrage can include sentiment-based risk and noise trader risk, which affect the ability of arbitrageurs to exploit mispricings without facing undue risk. Firm-specific risk can also be a limit if it affects the arbitrage strategy's outcome. Systematic risk, however, is a broader market risk that affects all investments and is not typically considered a specific limit to arbitrage strategies, which often seek to exploit price discrepancies without exposure to broader market movements.

Question 6

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

Accepted Answer

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

Question 7

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

Accepted Answer

A breakout of a resistance level indicates that there is strong buying pressure pushing the market higher, which is generally considered a sign of a bull market.

Question 8

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

Accepted Answer

The Dow theory does not state that waves are the most important. Rather, it emphasizes that both major and intermediate trends are important in understanding stock price movement.

Question 9

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

Accepted Answer

Buying a stock when its price approaches the support level is a strategy used by investors to buy stocks at relatively low prices. This is because the support level is considered the price at which buying demand is strong enough to prevent the stock price from falling further, hence providing a good buying opportunity for investors. Additionally, if the investor expects the price to rebound, then buying at the support level increases their chances of making a profit.

Question 10

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

Accepted Answer

According to the Elliott wave theory, market price movements occur in a series of impulsive and corrective waves. Proponents of this theory believe that an investor can buy at the beginning of an impulsive wave (Wave 1) and sell at the end of that same wave (Wave 5) in order to profit from the largest price movements. The correct answer is therefore B, as this best captures the strategy that Elliott wave theorists would use to profit from market movements.

Question 11

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.

Accepted Answer

Investor overconfidence can lead to all four behaviors: trading too frequently (I), investing too heavily in securities issued by their employer (II), earning lower rates of return due to the costs and poor timing associated with frequent trading (III), and exhibiting a "home bias" by investing too heavily in local companies (IV).

Question 12

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

Accepted Answer

According to the "hot-hand" fallacy, investors believe that recent winners have a higher chance of continuing to win, leading them to invest more in recent winners rather than recent losers. Therefore, investors are most apt to invest more in recent winners than in recent losers.

Question 13

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:

Accepted Answer

The belief that the investment adviser will be right 5 out of every 6 times is based on the law of small numbers, which is the expectation that a small sample size will represent the larger population with accuracy. However, this belief may not be accurate as the success rate of the adviser's recommendations may vary over time and may not necessarily follow a consistent pattern.

Question 14

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

Accepted Answer

The theory of recency bias suggests that investors believe that the financial markets will continue to perform as they have in the recent past. Therefore, option D, which states that the markets will continue to perform as they have over the past couple of years, is the best choice. The other options are not consistent with recency bias.

Question 15

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

Accepted Answer

A contrarian investor looks for buying opportunities when market sentiment is overly pessimistic. A higher MSI value like 0.82 indicates extreme pessimism, suggesting a potential buying opportunity.

Question 16

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

Accepted Answer

The self-attribution bias involves taking credit for successes and blaming failures on external factors such as bad luck, rather than personal inadequacy.

Question 17

Firm-specific risk can create a barrier to arbitrage when

Accepted Answer

The answer of Firm-specific risk can create a barrier to...

Question 18

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:

Accepted Answer

Mark's belief that gold will increase in value simply because it has lost value in the last five years demonstrates the gambler's fallacy. The gambler's fallacy is the belief that past outcomes affect future outcomes, despite each outcome being independent and random. In this case, Mark believes that gold is more likely to increase in value in the coming year because it has lost value for five years in a row, even though each year's value is unrelated to the others.

Question 19

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:

Accepted Answer

The clustering illusion refers to the tendency to see patterns in random events. In this context, investors might mistakenly believe that past performance (a pattern of good returns) will continue, leading them to invest more money with those managers, despite the randomness of investment returns.

Question 20

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

Accepted Answer

The answer of If all investors are bearish, the market...

Quiz 9: Behavioural Finance and the Psychology of Investing