H.66 Behavioral finance Flashcards
(23 cards)
Which of the following is NOT a bias associated with prospect theory?
A) Loss aversion
B) Overconfidence
C) Confirmation bias
D) Framing effect
Overconfidence
Explanation
Overconfidence is not a bias associated with prospect theory. Prospect theory, developed by Daniel Kahneman and Amos Tversky, primarily focuses on how people make decisions under uncertainty and risk, particularly in the context of gains and losses. It describes several biases and heuristics that influence decision-making, but overconfidence is not one of them.
The other options listed—loss aversion, confirmation bias, and framing effect—are all biases that are commonly associated with prospect theory:
Loss aversion refers to the tendency of individuals to strongly prefer avoiding losses over acquiring equivalent gains.
C) Confirmation bias is the tendency to search for, interpret, and remember information in a way that confirms one’s preconceptions or beliefs, which can affect how people evaluate prospects.
D) Framing effect involves the idea that the way information is presented or “framed” can significantly influence people’s decisions. This is a central concept in prospect theory, as different framings of the same decision problem can lead to different choices.
H.66 Behavioral finance
Which of the following is an example of anchoring bias?
A) A financial advisor recommends a stock based on its current market price
B) A client focuses on the first investment option presented to them and does not consider any others
C) A client is influenced by the behavior of their peers when making investment decisions
D) A client sells a stock after experiencing a loss and refuses to buy it again even though its value has increased
A client focuses on the first investment option presented to them and does not consider any others
Explanation: Anchoring bias occurs when people rely too heavily on the first piece of information they receive when making a decision. In this case, the client is anchored to the first investment option presented to them and does not consider any others.
H.66 Behavioral finance
Which of the following is NOT a heuristic associated with judgmental biases?
A) Availability heuristic
B) Representativeness heuristic
C) Overconfidence heuristic
D) Anchoring heuristic
Overconfidence heuristic
Explanation: Overconfidence bias is not a heuristic associated with judgmental biases. It is a separate cognitive bias that causes people to overestimate their own abilities and the accuracy of their predictions.
H.66 Behavioral finance
A client refuses to sell a losing stock because they believe it will recover soon. Which of the following behavioral biases is the client exhibiting?
A) Confirmation bias
B) Loss aversion
C) Overconfidence bias
D) Herding bias
Overconfidence bias
Explanation: Overconfidence bias causes people to overestimate their own abilities and the accuracy of their predictions. In this case, the client is overconfident in their belief that the losing stock will recover soon.
H.66 Behavioral finance
Which of the following is an example of confirmation bias?
A) A client only reads news articles that confirm their existing beliefs about the stock market
B) A financial advisor recommends an investment based on its past performance
C) A client follows the advice of their peers when making investment decisions
D) A client is influenced by the first piece of information they receive about an investment
A client only reads news articles that confirm their existing beliefs about the stock market
Explanation: Confirmation bias occurs when people seek out information that confirms their existing beliefs and ignore information that contradicts them. In this case, the client is only reading news articles that confirm their existing beliefs about the stock market.
H.66 Behavioral finance
Which of the following biases is associated with the disposition effect?
A) Loss aversion
B. Framing effect
C. Anchoring bias
D. Availability bias
Loss aversion
Explanation: The disposition effect is the tendency for investors to hold onto losing investments and sell winning investments too early. Loss aversion bias causes people to feel the pain of losses more strongly than the pleasure of gains, which can lead to the disposition effect.
H.66 Behavioral finance
Which of the following is an example of the framing effect?
A. A client chooses an investment based on its past performance
B) A financial advisor recommends a stock based on its current market price
C) A client is influenced by the behavior of their peers when making investment decisions
D) A client chooses an investment based on whether it is presented as a gain or a loss
A client chooses an investment based on whether it is presented as a gain or a loss
Explanation: The framing effect occurs when the way information is presented (or framed) affects how people perceive it and make decisions based on it. In this case, the client is choosing an investment based on whether it is presented as a gain or a loss, which is an example of the framing effect.
H.66 Behavioral finance
Which of the following is an example of the availability bias?
A) A client chooses an investment based on its past performance
B) A financial advisor recommends a stock based on its current market price
C) A client is influenced by the behavior of their peers when making investment decisions
D) A client overestimates the likelihood of a rare event because it is easy to recall
A client overestimates the likelihood of a rare event because it is easy to recall
Explanation: The availability bias occurs when people overestimate the likelihood of an event because it is easy to recall examples of it. In this case, the client is overestimating the likelihood of a rare event because it is easy to recall examples of it.
H.66 Behavioral finance
A client sells a stock after experiencing a loss, even though the stock’s value is likely to increase in the future. Which of the following behavioral biases is the client exhibiting?
A) Anchoring bias
B) Herding bias
C) Loss aversion
D) Overconfidence bias
Loss aversion
Explanation: Loss aversion bias causes people to feel the pain of losses more strongly than the pleasure of gains. In this case, the client is selling the stock after experiencing a loss because they are averse to the pain of the loss, even though the stock’s value is likely to increase in the future.
H.66 Behavioral finance
Which of the following is an example of the endowment effect?
A) A client overestimates the likelihood of a rare event because it is easy to recall
B) A client refuses to sell an investment for less than its purchase price, even though it is currently worth less than that
C) A client is influenced by the behavior of their peers when making investment decisions
D) A client chooses an investment based on its past performance
A client refuses to sell an investment for less than its purchase price, even though it is currently worth less than that
Explanation: The endowment effect occurs when people overvalue items they own, simply because they own them. In this case, the client is refusing to sell an investment for less than its purchase price, even though it is currently worth less than that, which is an example of the endowment effect.
H.66 Behavioral finance
John is a financial advisor who notices that his clients are often influenced by the behavior of their peers when making investment decisions. Which of the following biases is John’s clients exhibiting?
A) Confirmation bias
B) Herding bias
C) Framing effect
D) Overconfidence bias
Herding bias
Explanation: Herding bias occurs when people make decisions based on the behavior of their peers, rather than their own independent analysis. In this case, John’s clients are exhibiting herding bias.
H.66 Behavioral finance
Sarah is a financial advisor who notices that her clients tend to be overly confident in their ability to predict market movements. Which of the following biases are Sarah’s clients exhibiting?
A) Availability bias
B) Confirmation bias
C) Overconfidence bias
D) Loss aversion
Overconfidence bias
Explanation: Overconfidence bias causes people to overestimate their own abilities and the accuracy of their predictions. In this case, Sarah’s clients are exhibiting overconfidence bias.
H.66 Behavioral finance
Mike is a financial advisor who notices that his clients tend to focus on the first investment they hear about and are reluctant to consider other options. Which of the following biases are Mike’s clients exhibiting?
A) Anchoring bias
B) Confirmation bias
C) Status quo bias
D) Framing effect
Anchoring bias
Explanation: Anchoring bias occurs when people rely too heavily on the first piece of information they receive when making a decision, and then fail to adjust sufficiently when new information becomes available. In this case, Mike’s clients are exhibiting anchoring bias.
H.66 Behavioral finance
Lisa is a financial advisor who notices that her clients often make investment decisions based on recent market trends, rather than long-term goals. Which of the following biases are Lisa’s clients exhibiting?
A) Herding bias
B) Availability bias
C. Confirmation bias
D) Endowment effect
Herding bias
Explanation: Herding bias occurs when people make decisions based on the behavior of their peers, rather than their own independent analysis. In this case, Lisa’s clients are exhibiting herding bias by following recent market trends.
H.66 Behavioral finance
Bob is a financial advisor who notices that his clients tend to sell their investments after experiencing a loss, even if it means missing out on potential future gains. Which of the following biases are Bob’s clients exhibiting?
A) Loss aversion
B) Confirmation bias
C) Overconfidence bias
D) Endowment effect
Loss aversion
Explanation: Loss aversion bias causes people to feel the pain of losses more strongly than the pleasure of gains. In this case, Bob’s clients are exhibiting loss aversion by selling their investments after experiencing a loss, even if it means missing out on potential future gains.
H.66 Behavioral finance
Maria is a financial advisor who notices that her clients are more likely to invest in a company if they are familiar with the brand, even if it is not a good investment. Which of the following biases are Maria’s clients exhibiting?
A) Framing effect
B) Confirmation bias
C) Status quo bias
D) Availability bias
Availability bias
Explanation: Availability bias occurs when people overestimate the likelihood of an event because it is easy to recall examples of it. In this case, Maria’s clients are exhibiting availability bias by investing in a company they are familiar with, even if it is not a good investment, because the brand is easy to recall.
H.66 Behavioral finance
Sam is a financial advisor who notices that his clients tend to make decisions based on the most recent information they receive, rather than considering the overall picture. Which of the following biases are Sam’s clients exhibiting?
A) Confirmation bias
B) Anchoring bias
C) Availability bias
D) Recency bias
Recency bias
Explanation: Recency bias occurs when people place too much weight on the most recent information they receive, and fail to consider the overall picture. In this case, Sam’s clients are exhibiting recency bias.
H.66 Behavioral finance
Jane is a financial advisor who notices that her clients are more likely to take risks when they have recently experienced a gain and more likely to avoid risks when they have recently experienced a loss. Which of the following biases are Jane’s clients exhibiting?
A. Loss aversion
B. Confirmation bias
C. Framing effect
D. Recency bias
Recency bias
Explanation: Recency bias occurs when people place too much weight on the most recent information they receive and fail to consider the overall picture. In this case, Jane’s clients are exhibiting recency bias by taking risks after a gain and avoiding risks after a loss.
H.66 Behavioral finance
Mark is a financial advisor who notices that his clients tend to overestimate their own abilities when making investment decisions. Which of the following biases are Mark’s clients exhibiting?
A) Overconfidence bias
B) Confirmation bias
C) Hindsight bias
D) Anchoring bias
Overconfidence bias
Explanation: Overconfidence bias causes people to overestimate their abilities and the accuracy of their predictions. In this case, Mark’s clients are exhibiting overconfidence bias by overestimating their abilities when making investment decisions.
H.66 Behavioral finance
John is a financial advisor who notices that his clients often have difficulty admitting when they have made a mistake in their investment decisions. Which of the following biases are John’s clients exhibiting?
A) Confirmation bias
B) Hindsight bias
C) Overconfidence bias
D) Cognitive dissonance
Cognitive dissonance
Explanation: Cognitive dissonance occurs when people experience discomfort or tension when faced with new information that conflicts with their existing beliefs or behaviors. In this case, John’s clients are exhibiting cognitive dissonance by having difficulty admitting when they have made a mistake in their investment decisions.
H.66 Behavioral finance
What is one major emotion clients might feel when discussing their financial past?
A) Indifference
B) Excitement
C) Anxiety or shame
D) Eagerness
Anxiety or shame
Explanation: Clients might feel anxious or even ashamed about sharing their financial past, especially with a new financial advisor.
H.66 Behavioral finance
Jane, a 35-year-old individual, inherited a substantial sum from a family trust, which means she has never had to work a day in her life. However, she often finds herself unsatisfied with her activities and has been gradually depleting the trust’s principal. Jane assumes that her trustee will manage all financial concerns. As a CFP® professional advising Jane, what would be the MOST suitable approach to illustrate to her?
A) The trust funds have granted Jane the privilege of a carefree lifestyle.
B) The financial reliance on the trust has potentially hampered Jane’s drive, innovation, and ambition.
C) Jane might have developed a shopping addiction that requires attention.
D) The trust may have fostered feelings of guilt in Jane, leading to a complex relationship with wealth.
The financial reliance on the trust has potentially hampered Jane’s drive, innovation, and ambition.
Explanation: While all the options might have some relevance to Jane’s situation, option B addresses the core issue of Jane’s lack of motivation and satisfaction due to her complete dependence on the trust fund. This perspective encourages financial education and planning, promoting a more balanced and fulfilling approach to wealth.
H.66 Behavioral finance
As a CFP® professional, what is the best way to help clients deal with their past financial decisions?
A) Focus solely on the past
B) Critique every past decision
C) Recognize that they can’t change the past but discuss the present and future
D) Avoid discussing the past altogether
Recognize that they can’t change the past but discuss the present and future
Explanation: Acknowledge that they can’t change what happened in the past but focus on discussing where the client is now and where they are going in the future.
H.66 Behavioral finance
