The concept of behavioral finance has begun to be employed in investment management. Which of the following statements is CORRECT regarding behavioral finance and its potential affect on a client’s risk objectives? Behavioral finance implies that investors are:
A)
loss averse, rather than risk averse, and this may have an impact upon the investors' willingness to take risk.
B)
risk averse, rather than loss averse, and this may have an impact upon the investors' willingness to take risk.
C)
loss averse, rather than risk averse, and this may have an impact upon the investors' ability to take risk.
Behavioral finance suggests that investors may view risk of loss differently from risk of gain (i.e., that they are more risk seeking in the domain of losses). This is known as being loss averse. The investor’s psychological profile can affect their willingness to take risk. However, the ability to take risk is a more objective measure of what is appropriate given the client’s situation.
investors are loss averse, which means they prefer uncertain losses to certain losses.
investors exhibit biased expectations, due to overconfidence in their ability to forecast the future.
investors construct portfolios via asset segregation, meaning that they tend to focus on an asset’s individual investment features versus its impact on the overall portfolio position.
Which of the following statements about behavioral finance is CORRECT?
A)
Investors are more concerned with portfolio construction versus individual assets' characteristics.
B)
Behavioral finance assumes investors exhibit character traits different than those stipulated by traditional finance.
C)
Investors realize their lack of experience in forecasting.
The three major characteristics exhibited by traditional finance are risk aversion, rational expectations, and portfolio diversification. Behavioral finance assumes investors exhibit three other major characteristics which are loss aversion, biased expectations, and they construct portfolios via asset segregation. Most individual investors overestimate their ability to forecast the future.
Investor behavior and psychology allow classification according to risk preferences. The particular technique associated with this classification exercise is termed personality:
A)
assessing.
B)
typing.
C)
testing.
The particular technique is termed personality typing. Personality typing is an attempt to help both the investor and manager get a better understanding of an investor’s risk tolerance characteristics. Although no classification can accurately describe all investors, personality typing does give an indication to risk tolerance.
Behavioral finance models of asset pricing take into account economic considerations and add:
A)
individual selections.
B)
security specific characteristics.
C)
personal preferences.
In a world that accounts for behavioral factors, personal preferences are added to asset pricing models. Not only do basic economic relationships impact security prices but so do personal preferences. Investors’ likes and dislikes enter the pricing function.
Which of the following statements about appropriate investment planning is CORRECT?
A)
Individual investment planning could include the consultation of counsel.
B)
An appropriate investment objective for a typical 23-year-old investor is a low-risk strategy, such as capital preservation.
C)
It is not a good idea to get too specific when constructing an investment policy statement.
Consultation with tax counsel could be recommended for complicated tax situations and an estate counsel for estate issues. A 23-year-old investor should be more concerned about capital appreciation, not preservation. Investment policy statements are more useful the more specific they are.
Investor psychology indicates investors will form portfolios via which method?
A)
Pyramiding.
B)
Triangulating.
C)
Integrating.
Pyramiding is the concept applied to investor portfolio formation in which portfolios are created by matching layers of assets to specific goals. Each layer of assets is not particularly evaluated within an overall portfolio context.