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Portfolio Management and Wealth Planning【Reading 9】

All of the following are behavioral investor types identified by Pompian EXCEPT the:
A)
guardian.
B)
active accumulator.
C)
friendly follower.



The guardian is from the Bailard, Biehl, and Kaiser (BB&K) five-way model which classifies investors along two dimensions according to how they approach life in general. The first dimension, confidence, identifies the level of confidence usually displayed when the individual makes decisions. Confidence level can range from confident to anxious. The second dimension, method of action, measures the individual’s approach to decision making. Depending on whether the individual is methodical in making decisions or tends to be more spontaneous, method of action can range from careful to impetuous. The five behavioral types identified by the BB&K five-way model are the: adventurer, celebrity, individualist, guardian, and straight arrow.
The Pompian behavioral model identifies four behavioral investor types (BITs): passive preserver, friendly follower, independent individualist, and active accumulator. The Passive Preserver and the Active Accumulator tend to make emotional decisions whereas the Friendly Follower and Independent Individualist tend to use a more thoughtful approach to decision making.

Which of the following is most likely not one of the behavioral investor types identified by Pompian?
A)
The adventurer.
B)
The Independent individualist.
C)
The adventurer.



The adventurer is from the Bailard, Biehl, and Kaiser (BB&K) five-way model which classifies investors along two dimensions according to how they approach life in general. The first dimension, confidence, identifies the level of confidence usually displayed when the individual makes decisions. Confidence level can range from confident to anxious. The second dimension, method of action, measures the individual’s approach to decision making. Depending on whether the individual is methodical in making decisions or tends to be more spontaneous, method of action can range from careful to impetuous. The five behavioral types identified by the BB&K five-way model are the: adventurer, celebrity, individualist, guardian, and straight arrow.
The Pompian behavioral model identifies four behavioral investor types (BITs): passive preserver, friendly follower, independent individualist, and active accumulator. The Passive Preserver and the Active Accumulator tend to make emotional decisions whereas the Friendly Follower and Independent Individualist tend to use a more thoughtful approach to decision making.

TOP

Which of the following is least likely a limitation of classifying an investor into a behavioral type?
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 circumstances and psychological traits.
B)
The client portfolio constructed by the adviser most likely will not fall on the efficient frontier.
C)
Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don’t all act irrationally (or rationally) at the same time.


The client portfolio constructed by the adviser not falling on the efficient frontier is not a limitation but the result of classifying an investor into a behavioral type. It results in a portfolio that is better suited to the client given their behavioral biases.
Limitations of classifying investors into the various behavioral investor types include:
  • Individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.
  • An individual might display traits of more than one behavioral investor type, making it difficult to place the individual into a single category.
  • As investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.
  • 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 circumstances and psychological traits.
  • Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don’t all act irrationally (or rationally) at the same time.

TOP

Limitations of classifying investors into behavioral types would include all of the following EXCEPT:
A)
the resulting client portfolio is not the “rational” portfolio.
B)
individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.
C)
as investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.


The client portfolio constructed by the adviser not falling on the efficient frontier (the rational portfolio) is not a limitation but the result of classifying an investor into a behavioral type. It results in a portfolio that is better suited to the client given their behavioral biases.
Limitations of classifying investors into the various behavioral investor types include:
  • Individuals may simultaneously display both emotional biases and cognitive errors all the while seeming to act rationally, making it difficult to classify the individual according to behavioral biases.
  • An individual might display traits of more than one behavioral investor type, making it difficult to place the individual into a single category.
  • As investors age, they will most likely go through behavioral changes, usually resulting in decreased risk tolerance along with becoming more emotional about their investing.
  • 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 circumstances and psychological traits.
  • Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don’t all act irrationally (or rationally) at the same time.

TOP

Which of the following are uses of classifying investors into various types? Classifying investors into behavioral types:
A)
helps the advisor understand their client resulting in better overall investment decisions being made that are closer to the efficient frontier.
B)
allows the advisor to have a better understanding of how to approach their client when educating them on traditional finance concepts.
C)
gives the adviser the tools to be able to explain to the client why their portfolio should resemble the “rational portfolio” based on traditional finance concepts.



The goal of viewing the client/adviser relationship from a psychological perspective as compared to a purely traditional finance perspective is for the adviser to better understand their client and to make better investment decisions. By incorporating behavioral biases into clients’ IPSs, clients’ portfolios will tend to be closer to but not on the efficient frontier (the rational portfolio), and clients will be more trusting and satisfied and tend to stay on track with their long-term strategic plans. Ultimately, since everyone is happy, the result is a better overall working relationship between client and adviser. Clients who are at the extremes of risk aversion tend to approach investing very emotionally and are not interested in traditional finance concepts therefore educating them on these concepts is of little value to them and does not work.

TOP

Jean Stall, CFA, has just completed the yearly review for one of her clients Jeff Schaller. During the review she went over the original questionnaire he filled 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?
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 inapproan inappropriate product with the indexed annuity.
C)
Stall met with Schaller on a yearly basis.



Stall made several errors regarding the questionnaire and subsequent meeting:
  • The questionnaire should be re-administered during the yearly review to make sure any changes in the client’s circumstances are captured.
  • The questionnaire should be able to identify behavioral biases displayed by the client which there is no mention of this occurring.
  • Stall interpreted Schaller’s statement about not wanting to lose any money too literally resulting in an inappropriate product, the annuity which is a long term retirement product, being used for non-retirement savings. She should have inquired further into his statement to see if he really meant not to lose any money in an investment or if he is just overly risk averse.

TOP

Which of the following is least likely a way the success of the client / adviser relationship is measured?
A)
The adviser acts as the client expects.
B)
Both client and adviser benefit from the relationship.
C)
The adviser has been able to successfully grow their business year after year.



The success of the typical client/adviser relationship can be measured in four areas with each one being enhanced by incorporating behavioral finance traits:
  • The adviser understands the long-term financial goals of the client.
  • The adviser maintains a consistent approach with the client.
  • The adviser acts as the client expects.
  • Both client and adviser benefit from the relationship.

TOP

All of the following are prescribed methods of measuring the success of the client / adviser relationship EXCEPT the:
A)
client is satisfied with the return they are getting from their portfolio.
B)
adviser understands the long-term financial goals of the client.
C)
adviser maintains a consistent approach with the client.



The success of the typical client/adviser relationship can be measured in four areas with each one being enhanced by incorporating behavioral finance traits:
  • The adviser understands the long-term financial goals of the client.
  • The adviser maintains a consistent approach with the client.
  • The adviser acts as the client expects.
  • Both client and adviser benefit from the relationship.

TOP

All of the following are potential benefits of defining 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.



Choosing the optimal portfolio is still a matter of judgement—a tradeoff between risk and return, but the specification of risk is often much easier for the investor to understand. Both remaining statements are correct.

TOP

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.



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.

TOP

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