Reading 20: Goals-Based Investin....avioral Finance－LOS b 2008, individual, investment, setting

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 4: Private Wealth Management
Reading 20: Goals-Based Investing: Integrating Traditional and Behavioral Finance
LOS b: Explain the limitations of traditional risk measurement and risk profiling in setting investment policy for individual investors.

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Defining investor objectives in terms of mean and standard deviation:

A) may make it easier for the investor to make a connection between the investment policy and the investors own goals.

B) usually makes it less likely that the investor will deviate from the investment policy because of current market conditions.

C) will increase the complexity of the process for the investment advisor.

D) can make it difficult to estimate the probability that the objectives will be realized.

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Answer and Explanation

Defining investor objectives in terms of mean and standard deviation can make it difficult to estimate the probability that the objectives will be realized. Therefore, this also often makes it more difficult for the investor to see the connection between policy and their own goals, and may make it more likely that deviations from policy will occur. It also simplifies the process for the investment advisor.

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Investors who sell winning securities too soon and hold losing positions too long is an example of:

A) traditional finance.

B) both behavioral and traditional finance.

C) framing the investor's policy objectives in terms of standard deviation and expected percent return.

D) behavioral finance.

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Answer and Explanation

This is an example of behavioral finance. In traditional finance investors receive and interpret all relevant facts correctly and use them to make optimal decisions. In traditional finance investor's policy objectives are in terms of risk (standard deviation) and expected return in percent.

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Defining investor objectives in terms of mean and standard deviation:

A) may make it easier for the investor to make a connection between the investment policy and the investors own goals.

B) may make selecting an asset allocation easier for the individual.

C) makes it more difficult for the investment advisor to select a suitable benchmark index.

D) will typically simplify the process for the investment advisor.

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Answer and Explanation

Defining investor objectives in terms of mean and standard deviation will typically simplify the process for the investment advisor. However, this often makes it more difficult for the investor to see the connection between policy and their own goals, and may may make selecting an asset allocation more difficult for the individual. The selection of a benchmark is likely simplified if the investors objectives are specified in terms of mean and standard deviation.

tycoon

Defining investor objectives in terms of mean and standard deviation:

A) may make it easier to estimate the probability that the objectives will be realized.

B) may make selecting an asset allocation more difficult for the individual.

C) usually makes it less likely that the investor will deviate from the investment policy because of current market conditions.

D) makes it more difficult for the investment advisor to select a suitable benchmark index.

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Answer and Explanation

Defining investor objectives in terms of mean and standard deviation may make selecting an asset allocation more difficult for the individual, since it can be hard to see how the choices affect the probability of success. In addition, this method of goal definition often makes it can make it difficult to estimate the probability that the objectives will be realized, and may make it more likely that deviations from policy will occur. The selection of a benchmark is likely simplified if the investors objectives are specified in terms of mean and standard deviation.