2019 CFA level 3 qbank reading 9 behavioral finance and investment processes questions

10/11/2018

Learning Management System

Question #1 of 54
Mike McLaughlin is an economist who makes quarterly forecasts for the state of the economy
and interest rates. Last quarter, the economy did not grow as fast as McLaughlin predicted.
McLaughlin explains that his forecast was inaccurate by stating "This change in the economy
was due to a real estate market that slowed faster than many forecasters, including myself,
expected. If it weren't for the real estate market, my projection for GDP would have been
accurate." Which of the following is the best interpretation of McLaughlin's statement, from a
behavioral nance view? McLaughlin is using:

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A) an “if-only” defense for his inaccurate forecasts and his recognition of it will sharpen his

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abilities.

B) hindsight bias as a defense for his inaccurate forecasts and this will prevent him from
accurately evaluating his own abilities.

C) a self attribution defense for his inaccurate forecasts and this will prevent him from

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Question #2 of 54

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accurately evaluating his own abilities.

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Which of the following would least likely be viewed as rational behavior during a market

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bubble?

A) Investors believe the price of a stock will continue to go up therefore they buy more.

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B) A real estate portfolio manager has no suitable alternative investments to switch to.
C) The investor knows she is in a bubble but she doesn’t know where the peak is.

Question #3 of 54
An investor selling winning securities too soon and holding losing positions too long is an
example of:

A) representativeness.

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B) overcon dence.
C) the disposition e ect.

Question #4 of 54
When an investor extrapolates past data from a small sample size into a forecast this is most
likely indicative of:

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A) the recency bias.
B) fear of regret.

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Question #5 of 54

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C) hindsight bias.

Which of the following would least likely be considered a market anomaly?

A) Bubbles and crashes.

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B) Underperformance of stocks with relatively high PE ratios or low book-to-market values.

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expectations.

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C) The stock market continues to climb as investors are trading according to economic

Question #6 of 54
All of the following are potential bene ts of de ning portfolio objectives in terms of client
objectives EXCEPT:

A) it allows the investor to better connect the probability of goal attainment with
investment policy.
B) it may improve the likelihood that the investor will adhere to investment policy.
C) the optimal portfolio can then be determined analytically.

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Question #7 of 54
Bobby Steele, a software engineer at a local rm, has been investing for the past two years and
has been very successful. He shuns professional investment advice and in fact provides advice
to his neighbors and friends. He states that his investment philosophy consistently
outperforms the experts. Which of the following best describes the implications of Steele's
investment style?

A) Steele is likely to have low turnover in his portfolio and is likely to base stock valuation
on fundamental analysis.
B) Steele is likely to have low turnover in his portfolio and is likely to make unjusti ed bets.

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C) Steele is likely to have high turnover in his portfolio and is likely to make unjusti ed

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bets.

Joseph Brophy and Pamela Carr work in the collections department of Swank's, an upscale

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department store in downtown Cleveland. Swank's is a publicly traded company with more
than 400 locations nationwide, and is also rated by national publications as one of the best
places to work. Brophy and Carr like their jobs, and like the company for which they work. 
Swank's recently switched from a de ned-bene t plan to a de ned-contribution plan, and

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employees with vested pension assets were given lump sums, with the option of investing that
money in the new plan. Both Brophy and Carr have worked for Swank's for more than 10 years,

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and as such receive sizable payments, which they intend to move into the new plan. 

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On the day enrollment forms arrive at the Cleveland o ce, Brophy and Carr have lunch
together to discuss the new pension plan. The investment packet contains a short newsletter

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that provides historical performance data on the investment options. Here are the choices:
An S&P 500 Index fund.
A large-cap value fund.
A small-cap value fund.
A small-cap growth fund.
A mid-cap blend fund.
An aggressive-growth stock fund.

A foreign-stock fund.
A long-term bond fund.
A short-term bond fund.
Swank's stock, available at a 5% discount to market price.
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Brophy and Carr know nothing about investing, but the recent past returns of the funds look
pretty high, and Swank's stock has done very well in recent years. Carr, who is 15 years younger
than Brophy, likes the returns on some of the stock funds and on Swank's stock. Brophy is ve
years away from retirement and feels he's too old to learn about nancial management. During
his discussion with Carr, he remembers an article he read in Forbes years ago. He can recall
nothing about the article except that the writer said diversi cation was a good idea. Carr
responds by warning that you have to make bets on a winner if you expect to earn good
returns. 
Brophy assumes that Swank's wouldn't recommend any funds unless they were good, and in an

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e ort to diversify, puts 10% of his money into each option. 
Carr wants to earn the biggest returns possible, so she invests 50% of her money in Swank's

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stock and split the remaining cash between the small-cap growth fund and the aggressivegrowth fund. 

Twelve months after the start of the new pension plan, all Swank's employees have the

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opportunity to change their investment elections. Brophy sees that his portfolio is up roughly in
line with the S&P 500 Index, so he leaves his elections intact. Carr notes that Swank's stock has
fallen 25%, and the portfolio was roughly at with year-earlier levels. Grumbling, she changes
her allocation so the portion currently in Swank's stock is divided between the available bond

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funds.

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Question #8 of 54

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Which of the following least likely re ects Brophy's portfolio decisions?

A) 1/n diversi cation.

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B) Familiarity.

C) Availability bias.

Question #9 of 54
Carr's initial investment choices show she avoided falling into which behavioral characteristic?

A) Representativeness.
B) Overcon dence.
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C) Pyramiding.

Question #10 of 54
Brophy's initial investment choices show he has fallen prey to which of the following traps?

A) Familiarity.
B) Status quo bias.

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C) Naive diversi cation.

Question #11 of 54

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Swank's wants to improve its de ned-contribution pension plan. Which of the following actions
will be least helpful to employees?

A) Provide detailed nancial and performance data on the company stock.
B) Allow the employees to change their allocations more than once a year.

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C) Increase the number of fund options.

Question #12 of 54

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Brophy appears to be:

A) frame dependent.

B) loss averse.
C) prone to regret.

Question #13 of 54

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Neither Brophy nor Carr made optimal investment decisions. In the wake of the portfolio
rebalancing, which of the following statements best re ect the situation of which employee?

Has bestallocated
portfolio

B)

Carr

Neither Carr
nor Brophy

Brophy

Neither Carr
nor Brophy

C) Carr

Brophy

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A)

Exhibits
herding
behavior

Terry Shiver and Mary Trickett are portfolio managers for High End Investment Managers. High
End provides investment advice to wealthy individuals. As part of their annual review of their

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client portfolios, they review the appropriateness of their client portfolios given their clients'
return objective, risk tolerance, time horizon, liquidity constraints, tax situation, regulatory
situation, and unique circumstances.

Their boss, Jill Castillo, is concerned that Shiver and Trickett allow the clients' behavioral biases

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to enter into the asset allocation decision. She has asked them to review their notes from
meetings with clients and examine the clients' statement for potential biases. The information

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below is excerpts from their notes, along with the client's name.

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Tom Heggins: "In the past ve years, I have consistently outperformed the market averages in
my stock portfolio. It really does not take a genius to beat a market average, but I am proud to

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say that I have beaten the market averages by at least 2 percent each year and have not once
lost money. I would continue managing my portfolio myself because I know I could keep
beating the averages, but with a new baby on the way and a promotion to Senior Vice President
at my technology rm, I just don't have the time."
Joanne McHale: "The last three quarters were bad for my portfolio. I have lost about a third of
my portfolio's value, primarily because I invested heavily in two aggressive growth mutual
funds whose managers had o quarters. I need to get back that one-third of my portfolio's
value because I am only fteen years away from retirement and I don't have a de ned-bene t
pension plan. Because of this, I am directing Mary Trickett to invest my savings in technology
mutual funds. Their potential return is much higher and I believe I can make back that loss with
an investment in them."
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Jack Sims: "I enjoy bird watching and hiking outdoors. I am an avid environmental advocate and
will only invest in rms that share my concern for the environment. My latest investment was in
Washington Materials. Washington was recently featured in an environmental magazine for
their outstanding dedication to environmental protection. The CEO of Washington was also
featured on the cover of Fortune magazine. He has turned the rm around in the three years
he has been there. The rm was near bankruptcy, but now Washington is the leader in its niche
market, which is waterproof fabric for outdoor clothing and equipment."

Question #14 of 54

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Which of the following best describes Tom Heggins's behavioral characteristic in investment

A) Tom is overcon dent.
B) Tom uses anchoring.

Question #15 of 54

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C) Tom uses frame dependence.

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decisions?

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Which of the following best describes the potential problem with Heggins's investment strategy

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in regards to certainty overcon dence?

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A) He will overestimate the risk of his portfolio and overestimate the impact of an event on
stocks.

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B) He will underestimate the risk of his portfolio and overestimate the probability of
success.

C) He will underestimate the risk of his portfolio and set too narrow of con dence
intervals.

Question #16 of 54
Which of the following most likely explains Tom Heggins's behavior in investment decisions?

A) Tom is su ering from an illusion of knowledge in assessing his skills.
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B) Tom uses anchoring to assess his skills.
C) Tom uses the ceteris-paribus heuristic to assess his skills.

Question #17 of 54
Which of the following best describes Joanne McHale's behavioral characteristic in investment
decisions?

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A) Joanne’s regret too heavily in uences her investment decisions.
B) Joanne uses the ceteris-paribus heuristic.

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Question #18 of 54

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C) Joanne is loss averse.

Which of the following least accurately describes Jack Sims's behavioral characteristic in
investment decisions?

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A) Jack is using the representativeness bias.

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B) Jack would be classi ed as an Active Accumulator personality type.

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C) Jack is using the availability bias.

Question #19 of 54
Which of the following would Heggins, McHale, and Sims be least likely to use when making
investment decisions?

A) Fundamental analysis.
B) Feelings.
C) Emotions.

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Question #20 of 54
Analyst M routinely adjusts his previously vague forecasts to t new information that has just
been made available making his forecast look better than it actually was. Analyst Q judges the
probability of her forecast being correct on how well the available data ts the outcome. Which
of the following behavioral biases are M and Q displaying? M is displaying:

A) hindsight bias and Q is displaying representativeness.
B) illusion of control bias and Q is displaying self-attribution bias.

Question #21 of 54

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C) illusion of knowledge and Q is displaying availability bias.

When an investor stays with the default investor option and default contribution rate in a

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company retirement plan this is an example of:

A) conditional naïve diversi cation.
B) status quo bias.

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C) familiarity.

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Question #22 of 54

All of the following are prescribed methods of measuring the success of the client / adviser

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relationship EXCEPT the:

A) client is satis ed with the return they are getting from their portfolio.
B) adviser maintains a consistent approach with the client.
C) adviser understands the long-term nancial goals of the client.

Question #23 of 54

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Which of the following is least likely a way the success of the client / adviser relationship is
measured?

A) The adviser has been able to successfully grow their business year after year.
B) Both client and adviser bene t from the relationship.
C) The adviser acts as the client expects.

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Question #24 of 54
According to behavioral nance, which of the following best describes the components of

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individual investors' portfolios?

A) Their portfolios will be over concentrated in their employer’s stock and risky securities.
B) Their portfolios will be over concentrated in risky securities.

securities.

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Question #25 of 54

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C) Their portfolios will be over concentrated in their employer’s stock and domestic

According to behavioral nance, analysts often make excuses for their inaccurate predictions.

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Which of the following best represents the problem with this occurrence, from a behavioral
nance view?

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A) The excuses allow poor forecasters to stay in their positions when they should be
replaced.

B) Other investors depend on these forecasts, resulting in aggregate investment losses.
C) The excuses will prevent analysts from recognizing their own limitations.

Question #26 of 54

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Investor X works for company A and investor Y works for company B. Company A makes a
matching contribution into their employees' retirement funds in cash whereas company B
matches with company stock. Which of the following are the most likely behavioral traits
exhibited by both employees?

A) Investor X will purchase more company stock than investor Y with the nal proportions
being approximately equal in their retirement plans.
B) Investor Y will purchase more company stock than investor X.
C) Both investor X and Y will purchase company stock in approximately the same
proportions so the nal allocation of company stock is actually higher in investor Y’s

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Question #27 of 54

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All of the following are behavioral investor types identi ed by Pompian EXCEPT the:

A) active accumulator.
B) friendly follower.

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C) guardian.

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Question #28 of 54

Which of the following best characterizes overcon dence in expert forecasters, according to

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behavioral nance? Expert forecasters are overcon dent in their forecasting ability because:

A) of the positive reinforcement they receive from the media.
B) they feel their knowledge allows them to make more accurate forecasts.
C) they have access to information others do not.

Question #29 of 54
Which of the following is least likely a limitation of classifying an investor into a behavioral type?
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A) Even though two individuals may fall into the same behavioral investor type, the
individuals should not necessarily be treated the same due to their unique
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B) Individuals tend to act irrationally at unpredictable times because they are subject to
their own speci c psychological traits and personal circumstances. In other words,
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C) The client portfolio constructed by the adviser most likely will not fall on the e cient
frontier.

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Question #30 of 54

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Limitations of classifying investors into behavioral types would include all of the following
EXCEPT:

A) individuals may simultaneously display both emotional biases and cognitive errors all
the while seeming to act rationally, making it di cult to classify the individual according

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b h i
l bi
B) the resulting client portfolio is not the “rational” portfolio.

C) as investors age, they will most likely go through behavioral changes, usually resulting in

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decreased risk tolerance along with becoming more emotional about their investing.

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Question #31 of 54

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Which of the following is least likely a way to reduce overcon dence in analyst forecasts?

A) Gather a large amount of data from which to develop a forecast.
B) The analyst is properly self-calibrated through feedback from colleagues and superiors
along with a structure that rewards accuracy and forecasts that are unambiguous and
d il d
C) The analyst should seek a contrary opinion to their forecast based on evidence along
with using a large enough sample size and Bayes’ formula.

Question #32 of 54
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Jack Melby places his investments into di erent "mental accounts" with each investment being
tied to accomplishing a di erent goal. All the investments together comprise a pyramid where
the most conservative investments are on the bottom layer to meet his most immediate and
important goals. Riskier investments are represented higher up in the pyramid and used to
meet less immediate goals. This behavioral trait is:

A) not the most e cient from a traditional nance perspective but acceptable because the
portfolio tends to be fairly well diversi ed and if constructed properly from a behavioral
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k ih h i l
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B) called “mental accounting” and is not thought to be an acceptable way for investors to
allocate their assets.

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C) perceived as being ine cient and the investment adviser should try to persuade the
investor to allocate their assets to resemble an allocation based on traditional nance

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c

Question #33 of 54

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Which of the following are uses of classifying investors into various types? Classifying investors
into behavioral types:

A) allows the advisor to have a better understanding of how to approach their client when

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educating them on traditional nance concepts.

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B) gives the adviser the tools to be able to explain to the client why their portfolio should

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resemble the “rational portfolio” based on traditional nance concepts.
C) helps the advisor understand their client resulting in better overall investment decisions

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being made that are closer to the e cient frontier.

Question #34 of 54

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Jean Stall, CFA, has just completed the yearly review for one of her clients Je Schaller. During
the review she went over the original questionnaire he lled out to make sure the current
portfolio has not drifted too far from the original asset allocation as determined by the
questionnaire. The questionnaire was well designed to quantitatively determine Schaller's level

of risk aversion. One of Schaller's statements in the questionnaire was that he was comfortable
investing in stocks but did not want to lose any money in the stock market. As a result Stall took
a portion of his non-retirement money and put it in an indexed annuity which is a long term
investment guaranteed not to lose any money but will participate in any market gains. Which of
the following is NOT an error that Stall committed?

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A) There is no mention that behavioral traits were addressed in the questionnaire.
B) Stall took Schaller’s comment too literally and may have placed him in a potentially

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Question #35 of 54

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C) Stall met with Schaller on a yearly basis.

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inappropriate product with the indexed annuity.

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Brian Piezer is a participant in the NSS Enterprises 401(k) plan and started contributing to the
plan in 1998. Piezer's portfolio allocation when he started the plan in 1998 was as follows:

Allocation

Investment Option

20%

Reliant Large Cap Growth Fund

20%

Reliant Small Cap Value Fund

20%

Reliant Intermediate Bond Fund

20%

Reliant Money Market Fund

20%

Reliant International Stock Fund

Allocation

Investment Option

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October 2002. Piezer's investment allocation in 2002 is below:

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In March of 2000, the equity markets started to decline, eventually hitting a low point in

Reliant Large Cap Growth Fund

10%

Reliant Small Cap Value Fund

36%

Reliant Intermediate Bond Fund

30%

Reliant Money Market Fund

10%

Reliant International Stock Fund

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8%

Which of the following characteristics of a DC plan participant's portfolio is most re ective of

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Piezer's in 1998 and 2002 respectively?

Portfolio in
2002

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A) 1/n

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Portfolio in
1998

Status quo
diversi cation
bias
e ect
B)
Status quo
Framing
bias
C)

Framing

1/n
diversi cation
e ect

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Question #36 of 54
Leonard Busch is a employee of Matrix Technologies, and a participant in the Matrix
Technologies de ned contribution plan. The assets in the plan are the only investments he
owns. Busch's investment allocation is shown below.

Allocation

Investment Option
Yukon Large Cap Growth Fund

40%

Matrix Technologies Company Stock

15%

Yukon Intermediate Bond Fund

10%

Yukon Money Market Fund

15%

Yukon International Stock Fund

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20%

Which of the following factors is most likely to drive Busch's investment allocation?

A) Familiarity.

C) Status quo bias.

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Question #37 of 54

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B) 1/n diversi cation heuristics.

Heather Jones graduated from a prestigious Ivy League college in May, recently passed Level I

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of the CFA exam, and just landed her rst professional job as a junior portfolio manager
working with CFA charterholders for the Fortress mutual fund company. She works in a group

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setting comprised of a lead portfolio manager and one or more co- or junior portfolio
managers who together make the investment management decisions for a single mutual fund.
Jones has observed the following behavior during the committee meetings where the portfolio
managers discuss which investments should be a part of the portfolio: analyst A always sides
with and follows the lead of analyst B, analyst C tends to have a di erent opinion from the
group view but fears being ostracized therefore he rarely voices his opinion, manager D is very
aggressive and shoots down the opinions of others if they contradict his own and also likes to
argue with people. Jones is starting to wonder whether or not she made the right decision by
taking the job and has had several thoughts about the behavior at the meetings. Which of the
following of her thoughts is least re ective of how nancial decisions are typically made in a
group setting?
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A) “These people are displaying irrational behavior which is typical of group settings!”
B) “Their individual behavioral biases have become exacerbated in the group setting!”
C) “Decisions made at this level are made by professionals with similar backgrounds, the
committee should be functioning in a more e cient and e ective manner with little
di

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b

Question #38 of 54
Many de ned contribution plan participants tend to hold a large amount of assets in company

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stock relative to other asset classes. Which of the following characteristics of a DC plan

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participant's portfolio best re ects the reason behind this tendency?

A) Status quo bias.
B) Naive diversi cation.

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Question #39 of 54

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C) Familiarity.

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Which of the following is least likely to be a common bias found in analyst research?

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A) The analyst inappropriately tries to apply a probability to a random event.
B) The analyst nds evidence that con rms their forecast.
C) The analyst makes a decision based on incomplete information knowing the outcome

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could be unfavorable.

Question #40 of 54

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Steve Perlewitz, a retirement plan specialist for Mercantile Asset Advisors (MAA), is discussing
the behavioral characteristics of individual investors in de ned contribution retirement plans in
an e ort to educate MAA's sales team as they sell MAA's services. In his presentation, Perlewitz
makes the following comments:

An investor whose decisions are impacted by mental
Comment 1: accounting are likely to hold on to losing investments too long,
and sell winning investments too soon.

The 1/n diversi cation methodology used by many DC plan
participants is an example of naïve diversi cation.

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Comment 3:

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Since mental accounting tends to guide investors toward more
conservative asset classes, the portfolio of an investor
Comment 2: impacted by mental accounting will tend to be more
conservative than that of an investor who is not, assuming
similar return objectives.

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If a de ned contribution plan investor has an appropriate
Comment 4: allocation in their retirement plan, the same allocation should
also apply to their other investment accounts.
After listening to Perlewitz's presentation, sales team leader Vicki Bruning would be CORRECT
to agree with:

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A) Comment 3 only.

B) Comments 1, 2, and 4 only.

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C) Comments 2 and 3 only.

Question #41 of 54
Gina Arturo has an online brokerage account in which she frequently places trades. Which of
the following behavioral traits is she most likely exhibiting?

A) Disposition e ect.
B) Home bias e ect.
C) Overcon dence.

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Question #42 of 54
De ning investor objectives in terms of mean and standard deviation:

A) may make selecting an asset allocation more di cult for the individual.
B) usually makes it less likely that the investor will deviate from the investment policy
because of current market conditions.
C) may make it easier to estimate the probability that the objectives will be realized.

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Question #43 of 54

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According to behavioral nance, which of the following best represents how investors will
diversify a portfolio for their de ned contribution pension?

A) Using 1/n diversi cation.

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B) Using modern portfolio theory.

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C) According to their employer’s advice.

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Question #44 of 54

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Which of the following is NOT a reason for excessive trading taking place in discount brokerage
accounts as compared to company retirement plans?

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A) Individuals self-selecting into one account versus the other.
B) Framing bias.

C) The availability of investment options in one account as compared to the other.

Question #45 of 54
Which of the following behavioral biases are most commonly seen in employee retirement
plans?

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A) Status quo bias and naïve diversi cation also referred to as 1/n naïve diversi cation.
B) Familiarity, overcon dence, and naively extrapolating past returns.
C) Framing, loyalty e ect, and nancial incentives.

Question #46 of 54
Which of the following statements most accurately describes social proof bias? Social proof bias

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is when:

A) the individuals in a group start thinking and acting as if they are a single individual.

thus a functional member of the group.

Question #47 of 54

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C) an individual follows the beliefs of a group.

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B) an individual in a group setting is perceived by the group as being socially adept and

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Which of the following statements about the disposition e ect is least accurate? The disposition

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e ect is:

A) driven by fear of regret.

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B) when an individual holds onto winning stocks and sells losing stocks.

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C) seen in retail investment accounts.

Question #48 of 54
After Polly Shrum sells a stock, she avoids following it in the media. She is afraid that it may
subsequently increase in price. What behavioral characteristic does Shrum have as the basis for
her decision making?

A) Anchoring.
B) Fear of regret.
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C) Representativeness.

Question #49 of 54
Which of the following statements best re ects the relationship between company
management presenting reports in a favorable light and analysts' forecasts?

A) The way company management presents reports in uences analysts but they possess
the skills to be able to mitigate the in uence by company management.

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B) The way company management presents reports generally in uences analysts because

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they are also susceptible to behavioral biases.

C) Analysts can be unduly in uenced by the way management presents and frames
company reports thus analysts should be aware of the various biases management can
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Question #50 of 54

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b

Typical individual investors tend not to understand the e ects of correlation on their portfolio.

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Which of the following characteristics of a DC plan participant's portfolio best re ects the

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attempt to derive bene ts from the e ects of correlation even though the participant does not

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understand those e ects?

A) 1/n diversi cation heuristics.

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B) Familiarity.

C) Status quo bias.

Question #51 of 54

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Kelly Lieb and Don Carsner are discussing their investments in the Shrader Tire 401(k) de ned
contribution plan. Lieb and Carsner make the following statements in their conversation:

Lieb:

"Most of the money I have invested in our 401(k) plan is in
Shrader Tire stock. Management would not give it to us as a
company match if it were not a good investment.

Carsner:

"I allocate most of my money to Shrader Tire Company stock
as well. I don't know anything about the other investment
options, and I want to be loyal to the company."

Which of the following factors behind holding company stock best re ects Lieb's comment and

Bias
B)

Framing

Familiarity
Bias
Framing

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m

C) Framing

Familiarity
Bias

bo
ok
c

A) Familiarity

Carsner's
Comment

en
tre

Lieb's
Comment

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Carsner's comment respectively?

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Question #52 of 54

Which of the following best exempli es the structure of a committee that e ectively makes

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decisions?

A) The committee members get along well and there is little animosity or in- ghting
between the committee members.
B) The committee members are encouraged to speak out so di erent opinions are heard.
C) The committee is comprised of individuals from di erent backgrounds and where the
committee chair encourages people to voice their opinions even if it is contrary to the
i

Question #53 of 54
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10/11/2018

Learning Management System

According to behavioral nance, which of the following best describes how investors will invest
their retirement portfolio?

A) The investor will put most of their money in the less risky assets on the menu of their
employer’s de ned contribution plan unless the employer forces them to put the
j i
f h f d i h
k

B) The investor will put an equal dollar amount in each mutual fund on the menu of their
employer’s de ned contribution plan.
C) The investor will put most of their money in the less risky assets on the menu of their

.in

employer’s de ned contribution plan.

en
tre

Question #54 of 54

Which of the following is most likely not one of the behavioral investor types identi ed by

A) The adventurer.

bo
ok
c

Pompian?

B) The Independent individualist.

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m

C) The passive preserver.

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