Topic 5B: Behavioral Economics and Behavioral Finance 1) FM05B\ C \\ Bounded Behavior \2\\
Behavioral economists who follow the lead of Nobel Prize-winner Herbert Simon [1916-2001] would be least likely to identify as “bounded” the widespread human attribute of:
2) FM05B\ B \\ Bounded Behavior \2\\
No one can perfectly perform all the mental gymnastics needed to process information so that all their decisions are mathematically optimal, so most people rely heavily on mental shortcuts that cognitive psychologists and behavioral economists call: (a) windage.
(d) rational ignorance.
3) FM05B\ C \\ Behavioral Economics and Behavioral Finance \2\\
Research into behavioral economics and behavioral finance are least consistent with:
(a) Keynesian beauty contests.
(b) investors being less likely to sell if the price of a stock goes down than if it goes up. (c) theories of rational expectations and efficient markets.
(d) failures to ignore fixed costs when making rational decisions. (e) prospect theory.
(f) people being risk avoiding when faced with risky gains but risk seeking when they
try to avoid risky losses.
4) FM05B \ D \\ Behavioral Economics \3\\
Recent research by behavioral economists tends to be least consistent with the: (a) Keynesian “beauty contest” theory of investor behavior.
(b) the endowment effect.
(c) the “snake-bit” effect.
(d) standard economic assumptions that people are unfailingly rational and forward
(e) assumption of Adam Smith that we tend to be more concerned with things that are
near us than events that are distant.
5) FM05B\ D \\ Home Bias \2\\
Investors are exhibiting a “home bias” if they:
(a) keep most of their funds in bank deposits instead of economic capital. (b) sell quickly whenever one of their financial assets rises more than a target
(c) buy stocks only in firms in which they already own equity shares. (d) diversify inadequately by focusing on the stocks of local or domestic firms while
largely ignoring stocks in distant or foreign firms.
6) FM05B\ E \\ Home Bias \2\\
The fact that roughly 15% of Coca Cola stock is owned by financial investors who live in Georgia, where Coca Cola’s headquarters are located, is evidence of a:
(a) familiarity effect.
(b) winner’s curse effect.
(c) local flavor effect.
(d) domesticated effect.
(e) home bias effect.
7) FM05B\ C \\ Endowment Effect \2\\
People being more likely to ask for a higher price for an asset that they already own than they would be willing to pay for the same asset if they did not own it is known as the:
(a) tournament effect.
(b) winner’s curse effect.
(c) endowment effect.
(d) buyer’s remorse effect.
(e) quid-pro-quo effect.
8) FM05B\ B \\ Keynesian Beauty Contest \2\\
Portfolio structures based on individual investors’ assessments of how consensus views about alternative investments will affect the future values of these assets conform to the model known as the:
(a) efficient markets model.
(b) Keynesian beauty contest.
(c) value investing approach.
(d) theory of strategic market timing.
(e) strategic expectations theory.
9) FM05B\ C \\ House Money Effect \2\\
Supremely confident after winning $500 dollars playing poker in a casino, Chris put it all on number three at the roulette wheel. This action is known by behavioral economists as the:
(a) free money effect.
(b) risk neutral effect.
(c) house-money effect.
(d) risk seeking effect.
(e) stupid money effect.
10) FM05B\ D \\ House Money Effect \2\\
The “house-money” effect is in play if financial investors:
(a) sell a stock to cash in on a short-term profit after a stock rises in price. (b) acquire insider information that is likely to increase the value of a stock. (c) buy stock on margin by borrowing from a brokerage firm.
(d) take greater risks after generating higher rates of return than expected. (e) receive inherited funds only after a longer wait than expected. 11) FM05B\ D \\ Animal Spirits \2\\
A reasonable synonym for irrational exuberance is:
(a) excessively positive inertia.
(b) myopic ecstasy.
(c) misplaced pessimism.
(d) bounded buoyancy.
(e) rampant optimism.
12) FM05B\ A \\ Illusion of Control Fallacy \2\\
A common logical error is for people who buy lottery tickets to view their probability of winning as:
(a) higher if they pick numbers themselves than if the numbers are assigned randomly
by a machine.
(b) lower if the lottery prize has grown significantly because it has not been won in
(c) the same whether they buy a ticket or not.
(d) higher for larger multi-state lotteries than for smaller single in-state lotteries.
13) FM05B\ E \\ Illusion of Control Fallacy \2\\
Overconfidence that leads to under-diversification and excessive risk-taking by financial investors is most common among:
(a) recently retired baby-boomers.
(b) married women.
(c) single women.
(d) married men.
(e) single men.
14) FM05B\ B \\ Sunk Cost Effect \2\\
Financial investors tend to be most reluctant to sell stock if:
(a) rumors begin circulating that the top manager has accepted a job with a different
(b) its current price is significantly less than the price at which they purchased it. (c) they acquire insider information that a firm is experiencing unexpectedly low
revenues or unexpectedly high costs.
(d) the stock is primarily traded in deep markets.
(e) the current price of the stock reflects a significant recent increase. 15) FM05B\ A \\ Sunk Cost Effect \2\\
An argument that we should continue the War in Iraq until we win because otherwise the $3 trillion already committed or spent will have been wasted is evidence of the: (a) sunk cost effect.
(b) illusion-of-control effect.
(c) patriotism fallacy.
(d) home-budget bias effect.
(e) chauvinism fallacy.
16) FM05B\ B \\ Sunk Costs and Rational Decisions \ 2 \\
After losing a big pot in a poker game when his flush was beat by a full house, John is most likely to be successful in subsequent hands if he:
(a) become a lot more cautious about every decision.
(b) views his losses as sunk costs and then bases the play of each hand on expectations
about future gains or losses.
(c) manifests a “snake-bit” effect that is greater than his “house money” effect.
(d) recognizes that luck comes in streaks, and that his lucky opponent is likely to
continue to be lucky.
(e) plays more aggressively to make up for the loss.
17) FM05B\ D \\ “Snake Bite” and “Break-even” Effects \2\\
Financial investors who have recently lost significant amounts of wealth due to a drop in the values of their stock portfolios frequently err by tending to: (a) rely excessively on advice from stock brokers.
(b) erratically shift from bonds to stocks, and then back again, thereby incurring
excessive transaction costs.
(c) focus excessively on low variable costs, while ignoring high sunk costs. (d) become overly risk averse because of the “snake-bite” effect, or excessively willing
to take risk because of the “break-even” effect.
(e) over-value the advice given by friends or acquaintances who have invested more
18) FM05B\ A \\ “Snake Bite” Effect \2\\
Financial investors who have recently lost significant amounts of wealth and who consequently become extraordinarily risk averse are exhibiting the: (a) snake-bite effect.
(b) loser’s curse effect.
(c) punch-drunk effect.
(d) buyer’s remorse effect.
(e) quid-pro-quo effect.
19) FM05B\ B \\ Risk Aversion and Transaction Costs \2\\
Several studies suggest that married middle-aged women tend to reap higher average rates of return on financial investments that do young single men primarily because these women more commonly:
(a) spend extra time doing basic analysis before they buy a security. (b) follow strategies of “buy and hold.”
(c) intuitively understand the long run impact of new financial information. (d) have better access to insider information about their employers’ business plans
before these plans are announced.
(e) diversify and don’t “put all their eggs” into one basket.
20) FM05B\ D \\ Actual Rates of Return \2\\
There is systematic overstatement of the annual percentage by which the average rates of return on blue-chip stocks listed in the Dow-Jones Industrial index have historically out-performed say, comparably risky bonds, because:
(a) interest on bonds is exempt from federal income taxes, but capital gains on stocks
are taxed as income.
(b) asymmetric information results in widespread overstatement of increases in blue
(c) stock brokers prefer to sell stocks instead of bonds.
(d) the rates of return for “delisted” stocks are not included in these averages.
21) FM05B \ C \ A3925 \ Prospect Theory and The Reflection Effect \3\\ Consider the “gamble”  $1000 with certainty, versus  zero with probability 0.50,
and $2,200 with probability 0.50. Now consider the gamble  zero change with
probability 0.95, and negative $25,000 with probability 0.05, versus  negative $1000
with certainty. An individual who prefers option  to option , and option  to
option  exhibits:
(a) risk averse behavior when considering both potential gains and potential losses. (b) risk loving behavior when considering both potential gains and potential losses. (c) risk averse behavior when considering potential gains and loss averse [risk-loving]
behavior when considering potential losses.
(d) risk loving behavior when considering potential gains but risk averse behavior when
considering potential losses.
22) FM05B \ C \\ Loss Aversion and Risk Loving \3\\
A synonym for the risk-seeking [or risk-loving] behavior most people seem to exhibit when confronted with certain forms of risky potential losses is:
(b) uncertainty phobia.
(c) loss aversion.
(d) dysfunctional heroism.
(e) peak-end dominance.
23) FM05B \ A \\ Bias of Representativeness \3\\
Financial investors who interpret the past business operations of a firm and the past performance of the stock when making decisions on investments are being affected by the psychological bias known as:
(c) cognitive dissonance.
(e) financial myopia.