Question 1

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

This assumption is best described as the gambler's fallacy, which is the belief that future probabilities are altered by past events when in reality, each event is independent and the past outcomes have no impact on future outcomes. In this case, Tricia's belief that the stock will have a high positive rate of return because it has lost money in the past three years is an example of the gambler's fallacy.

Question 2

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

Accepted Answer

The endowment effect refers to the tendency of people to assign a higher value to items simply because they own them. This can lead to irrational behavior in buying, selling, and trading goods.

Question 3

Which one of the following statements is correct regarding prospect theory?

Accepted Answer

Prospect theory suggests that people tend to feel the pain of losing money more than the pleasure of gaining the same amount of money. In fact, studies have shown that in typical investors, the emotional pain felt from losing $1 is approximately twice as strong as the emotional pleasure felt from gaining $1.

Question 4

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

This is an example of the endowment effect, which is the tendency for people to value something they already possess more than something they do not have. Krista's change in attitude towards the value of Overland stock is influenced by the fact that she is inheriting shares and now feels a sense of ownership and attachment to them. She is now more likely to view them as valuable and a good buy, even though her previous analysis suggested otherwise.

Question 5

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, that 80 percent of your investments will outperform the market over the long term. This belief is based on the:

Accepted Answer

The belief that following the adviser's advice will result in outperformance of 80 percent of investments over the long term is based on the law of small numbers, which is the erroneous belief that small samples will be representative of the larger population. Just because four out of the last five stocks recommended have outperformed the market, it does not necessarily mean that the same trend will continue in the long term.

Question 6

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

Accepted Answer

Mental accounting refers to the tendency of individuals to think of money in separate categories or "accounts" based on various criteria, such as the source or purpose of the funds. In this case, associating a security's gains or losses based on its purchase price is an example of mental accounting, as it creates an account in the individual's mind based on the initial investment.

Question 7

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 8

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

Accepted Answer

Making decisions in broad terms allows investors to consider a variety of factors that may impact overall performance, such as market trends, economic conditions, and geopolitical events. Focusing solely on historical performance, potential losses, or individual securities may result in a narrow perspective that doesn't consider the bigger picture. Similarly, historical costs may not reflect current market conditions and may not be as relevant to current investment decisions.

Question 9

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 10

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 11

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

Accepted Answer

Current research suggests that overconfidence tends to result in lower returns. Studies have shown that investors who trade more frequently or who are overly confident in their abilities tend to have lower investment returns. The other statements are not supported by current research.

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

Peter's hesitation stems from his fear of regretting his decision, indicating that he is suffering from regret aversion, which is the tendency to prefer avoiding losses to achieving gains.

Question 13

Phil 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 of winning $100,000. Which type of behavior is he displaying if he spins the wheel?

Accepted Answer

Phil is taking a risk by spinning the wheel instead of accepting the guaranteed $500. Therefore, he is displaying risk-taking behavior.

Question 14

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 the financial markets will continue to perform as they have over the past couple of years. This is because investors tend to overweight recent events and experiences, leading them to believe that current trends will continue into the future. Therefore, choice D is the best answer.

Question 15

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

Accepted Answer

The self-attribution bias involves taking credit for success and blaming failure on external factors such as luck.

Question 16

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

Accepted Answer

This behavior is a result of overconfidence, where investors believe they have a superior understanding of their employer and its prospects, and therefore become too heavily invested in the securities issued by the company.

Question 17

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 means that he is ignoring the effects of inflation on the value of money. Money illusion is a cognitive bias where people believe that the nominal value of money is more important than its real value.

Question 18

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 19

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

Accepted Answer