hinsafdar

Typical individual investors tend not to understand the effects of correlation on their portfolio. Which of the following characteristics of a DC plan participant’s portfolio best reflects the attempt to derive benefits from the effects of correlation even though the participant does not understand those effects?

A) 1/n diversification heuristics.

B) Familiarity.

C) Status quo bias.

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Feeling that they should spread out their risk, but not knowing how leads to the 1/n diversification heuristic. Often times, participants will only have a rough understanding of the effects of correlation and diversification and will simply divide their assets equally over the investment options in the plan in an attempt diversify their portfolio.

hinsafdar

Leonard Busch is a employee of Matrix Technologies, and a participant in the Matrix Technologies defined contribution plan. The assets in the plan are the only investments he owns. Busch’s investment allocation is shown below.

Allocation	Investment Option
20%	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

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

A) Status quo bias.

B) Familiarity.

C) 1/n diversification heuristics.

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Looking at Busch’s allocation, he obviously has a disproportionate amount of Matrix Technologies company stock. DC participants tend to hold excess stock of the company they work for due to familiarity and a perceived endorsement by management. Familiarity refers to investors selecting stocks with which they are comfortable with or have a proximity to. If company stock is offered as an investment option in a defined contribution plan, participants may feel a sense of control or allegiance to the firm and hold more company stock than is sensible, which is an effect of familiarity. Note that Busch’s assets are not equally divided among investment options, which means the 1/n diversification heuristic would not seem to apply. Status quo bias is clearly not the best answer given the weight in company stock.

hinsafdar

Many defined contribution plan participants tend to hold a large amount of assets in company stock relative to other asset classes. Which of the following characteristics of a DC plan participant’s portfolio best reflects the reason behind this tendency?

A) Familiarity.

B) Status quo bias.

C) Naive diversification.

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DC participants tend to hold excess stock of the company they work for due to familiarity which is the tendency for individuals to invest in where they are most comfortable or familiar which could be the company they work for. Naive diversification is allocating an equal amount of retirement savings to each investment option. Note that the status quo bias refers to a lack of action on the part of the participant.

hinsafdar

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

Lieb:	"Most of the money I have invested in our 410(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 reflects Lieb’s comment and Carsner’s comment respectively?

Lieb's Comment

Carsner's Comment

A) Familiarity bias Familiarity bias

B) Framing Familiarity bias

C) Framing Framing

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Even without direct encouragement by the plan sponsor, employees tend to invest more in their company’s stock that would be warranted from a diversification standpoint. Lieb’s and Carsner’s comments are reflective of the two primary factors that contribute to DC plan participants holding company stock: framing and familiarity bias. Lieb’s comment reflects framing which refers to the misconception that by matching the employee's contribution with company stock the sponsor is implicitly endorsing it as a good investment. Carsner’s comment is reflective of familiarity bias, which refers to investors selecting stocks with which they are comfortable with or have a proximity to. If company stock is offered as an investment option in a defined contribution plan, participants may feel a sense of control or allegiance to the firm and hold more company stock than is sensible, which is an effect of familiarity.

hinsafdar

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

A) the disposition effect.

B) representativeness.

C) overconfidence.

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This is the definition of the disposition effect.

hinsafdar

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

A) The analyst makes a decision based on incomplete information knowing the outcome could be unfavorable.

B) The analyst finds evidence that confirms their forecast.

C) The analyst inappropriately tries to apply a probability to a random event.

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Biases specific to analysts performing research are usually related to the analysts collecting too much information, which leads to the illusions of knowledge and control and to representativeness, all of which contribute to overconfidence. Two other common biases found in analysts’ research are the confirmation bias and the gambler’s fallacy.
The confirmation bias (related to confirming evidence) relates to the tendency to view new information as confirmation of an original forecast.
The gambler’s fallacy, in investing terms, is thinking that there will be a reversal to the long-term mean more frequently than actually happens. A representative bias is one in which the analyst inaccurately extrapolates past data into the future. An example of a representative bias would be classifying a firm as a growth firm based solely on previous high growth without considering other variables affecting the firm’s future.