Behavioral Finance - Reading 7: Heuristic-Driven Bias: The

statements, following, advice, white

Q1. Martina Blackwood has not been doing well with her investments. She consults Ben Haifen, CFA, for some advice. Which of Haifen's following statements indicates that Blackwood has a heuristic-driven bias?

A) Blackwood tends to hold onto her losers too long.

B) Blackwood's most valuable lessons were learned through her own mistakes.

C) Blackwood doesn't like fixed-income investments because she doesn't understand them.

Q2. Which of the following steps is least likely to be included in the process of developing heuristic-driven bias?

A) Reliance on rules of thumb for investment decisions.

B) Receiving bad advice.

C) Making mistakes.

Q3. Which of the following is least likely a heuristic learning process?

A) Experimentation.

B) Research.

C) Trial and error.

Q4. 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 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 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 below is excerpts from their notes, along with the client’s name.

Tom Heggins: “In the past five 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 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 firm, 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 off quarters. I need to get back that one-third of my portfolio’s value because I am only fifteen years away from retirement and I don’t have a defined-benefit 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.”

Jack Sims: “I enjoy bird watching and hiking outdoors. I am an avid environmental advocate and will only invest in firms 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 firm around in the three years he has been there. The firm was near bankruptcy, but now Washington is the leader in its niche market, which is waterproof fabric for outdoor clothing and equipment.”

Which of the following best describes Tom Heggins’s behavioral characteristic in investment decisions?

A) Tom is overconfident.

B) Tom uses frame dependence.

C) Tom uses anchoring.

Q5. Which of the following best describes the potential problem with Heggins’s investment strategy?

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

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

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