Prelim

Question 1

the study of how emotions, habits, and thinking patterns affect the way people make financial decisions.
It challenges traditional finance by recognizing that investors often act irrationally due to psychological and emotional biases. It integrates psychology and sociology to explain real-world financial behaviors.

Answer 1

Behavioral Finance

Question 2

assumes people always act rationally with money.
It is based on the assumption that individuals are rational, always make optimal decisions, and aim to maximize utility.

Answer 2

Traditional financial

Question 3

Key concepts of Behavioral Finance

Answer 3

1. Impulsive spending
2. Peer influence and social pressure
3. Fear of missing out
4. Difficulty saving money
5. Overconfidence in financial decisions
6. Mental accounting

Question 4

Buying things without thinking, often because of emotions or advertisements. - Example: Purchasing the latest gadget just because it looks cool, without checking if it’s necessary.
- Why it matters: Impulse buying can lead to financial regret and unnecessary expenses.

Answer 4

Impulsive spending

Question 5

Making financial decisions based on what others are doing.
- Example: Buying expensive clothes or a new phone just to fit in.
- Why it matters: Following trends without thinking can lead to overspending and financial stress.

Answer 5

Peer influence and social pressure

Question 6

• Feeling the need to spend money to be part of an experience or trend. - Example: Going to an expensive concert even if you can’t afford it, just because friends are going.
  
  • Why it ma?ers: can lead to unnecessary spending and poor financial choices.

Answer 6

Fear of missing out

Question 7

Choosing immediate rewards over long-term financial security.
- Example: Spending all your money on entertainment instead of saving for future needs.
- Why it ma?ers: Learning to save early builds financial stability and independence.

Answer 7

Difficulty Saving Money

Question 8

• Thinking you know more about money than you actually do, leading to risky choices.
  
  • Example: Spending all your earnings assuming you’ll always have more money in the future.
• Why it ma?ers: can lead to poor money management and financial problems later.

Answer 8

Overconfidence in Financial Decisions

Question 9

Treatng money differently based on where it comes from. - Example: Spending gift money freely but being careful with money earned from a job. - Why it ma?ers: Viewing all money equally helps with be?er budge9ng and saving.

Answer 9

Mental accounting

Question 10

Decision-Making Errors and Biases

Answer 10

Cognitive Bias
Emotional Bias

Question 12

These biases arise from faulty reasoning or mental shortcuts (heuristics) that can lead to irrational financial decisions.

Answer 12

Cognitive Biases

Question 13

These biases stem from emotions rather than logical reasoning and often lead to poor financial decisions.

Answer 13

Emotional Biases

Question 14

Cognitive Biases

Answer 14

1. Overconfidence Bias
2. Confirmation Bias
3. Anchoring bias
4. Representativeness bias
5. Hindsight bias
6. Mental accounting

Question 15

Investors overestimate their knowledge, skills, or ability to predict the market.
Example: A trader makes risky bets because they believe they can consistently beat the market.

Answer 15

Overconfidence Bias

Question 16

People seek out and favor information that supports their existing beliefs while ignoring contradictory evidence. · Example: An investor believes a stock will rise and only reads positive news about it while ignoring warning signs.

Answer 16

Confirmation Bias

Question 17

Investors rely too heavily on initial information (the “anchor”) when making decisions.
Example: An investor refuses to sell a stock that dropped from P100 to P50 because they are anchored to the original purchase price.

Answer 17

Anchoring bias

Question 18

People assume that past patterns will continue in the future, often leading to wrong conclusions.
· Example: Seeing a stock rise for five days and assuming it will keep rising indefinitely.

Answer 18

Representativeness bias

Question 19

Investors believe that past events were predictable, even though they weren’t.
Example: After a stock market crash, people say, “I knew this would happen!”—even though they didn’t act on it before

Answer 19

Hindsight bias

Question 20

Treating money differently based on its source or intended use. ·
Example: Splurging a lottery win but being frugal with salary income, even though it’s all money.

Answer 20

Mental accounting

Question 21

Emotional Biases

Answer 21

1. Loss aversion
2. Herd mentality
3. Regret aversion
4. Status quo bias
5. Self-control bias

Question 22

People fear losses more than they value equivalent gains (also known as Prospect Theory).
· Example: Holding onto a losing stock because selling it would make the loss “real,” even though it’s better to cut losses.

Answer 22

Loss aversion

Question 23

Investors follow the crowd, assuming that the majority must be right.
· Example: Buying a stock just because “everyone else is doing it” (leading to bubbles).

Answer 23

Herd mentality

Question 24

Fear of making the wrong choice leads to inaction or poor decisions. ·
Example: Not investing in the stock market because of fear of losing money, even though long-term investing builds wealth.

Answer 24

Regret aversion

Question 25

Preferring to do nothing rather than making a change, even when a change would be beneficial. · Example: Sticking to a low-interest savings account instead of moving money to higher-yield investments.

Answer 25

Status quo bias

Question 26

Struggling with short-term temptations over long-term financial goals. · Example: Spending all your money on luxury items instead of saving for retirement. · Decision-Making Errors and Biases

Answer 26

Self-control bias

Question 28

How to overcome these biases?

Answer 28

1. Awareness 2. Diversification 3. Long-term thinking 4. Data-driven decisions 5. Seeking advice

Question 29

Recognizing biases helps reduce their impact.

Answer 29

Awareness

Question 30

Avoid putting all money in one stock due to overconfidence.

Answer 30

Diversification

Question 31

Avoid panic-selling during market downturns.

Answer 31

Long-term thinking

Question 32

Use logic, not emotions, when making investments.

Answer 32

Data-driven decisions

Question 33

A financial advisor can provide an unbiased perspective.

Answer 33

Seeking advice

Question 34

Building blocks of Behavioral Finance

Answer 34

1. Heuristics 2. Prospect theory 3. Market inefficiencies 4. Emotional and cognitive Biases

Question 35

People often rely on rules of thumb or mental shortcuts when making financial decisions, especially in complex situations. While it can be helpful, they often lead to systematic biases. People use simple rules to make financial decisions, often leading to biases.

Answer 35

Heuristics

Question 36

Developed by Daniel Kahneman and Amos Tversky, this theory states that people feel losses more intensely than equivalent gains (loss aversion). This leads to irrational decision-making.

Answer 36

Prospect theory

Question 37

Traditional finance assumes markets are efficient, but behavioral finance argues that investor psychology leads to inefficiencies such as bubbles, crashes, and anomalies. Psychological biases cause financial markets to behave irrationally.

Answer 37

Market inefficiencies

Question 38

Investor decisions are influenced by emotions and cognitive errors, leading to deviations from rationality.

Answer 38

Emotional and cognitive Biases

Question 39

Making decisions based on easily available information (e.g., overestimating the risk of stock crashes due to recent news).

Answer 39

Availability bias

Question 40

Investors take more risks to avoid losses than to achieve gains.

Answer 40

Risk asymmetry

Question 41

The way a decision is presented affects choices (e.g., people prefer a “90% chance of success” over a “10% chance of failure” even though they are the same).

Answer 41

Framing effect

Question 42

Investors either panic (selling too much) or get overconfident (buying too much).

Answer 42

Overreaction and Underreaction

Question 43

It happens when the price of something (like a stock, cryptocurrency, or real estate) gets way too high because people keep buying, even though it’s not really worth that much. Eventually, it pops, and prices crash

Answer 43

Bubbles and crashes