Question

QUESTION 41

1. Sally Homes invested in a diversified portfolio of equities about 5 years ago. Overall, the performance has been in line with the market. However, Stock A, which Sally has always thought was a good company, has recently been handily outperforming the averages. Despite recent news articles and analyst reports indicating a potential slowdown in earnings, Sally moved an additional 5% of her portfolio into Stock A. Which of the following behavioral mistakes may she have made?

   		a. Representativeness.
   		b. Cognitive dissonance.
   		c. Irrational escalation.
   		d. Both b & c.

QUESTION 42

1. John Bell, a money manager at a large regional investment firm, has been outperforming the market for several years. He's considering a large investment in Stock Q because the company's last three product introductions sold poorly. He thinks the company is well managed, but just had bad luck recently. He sorted through several analyst reports and found two that support his opinion. If he buys the stock, which behavioral mistakes may he be making? (1) Overconfidence. (2) Anchoring. (3) Gambler's fallacy. (4) Confirmation bias.

   		a. 1 and 2.
   		b. 2 and 3.
   		c. 1, 3 and 4.
   		d. 1, 2, 3 and 4.

Answer 1

Question 41

The answer is Option C

Explanation : Irrational escalation refers to the belief when investors are so confident that the price of an asset will keep going up, they lose sight of its underlying value. This is evident in Sally's behaviour when Analysts are suggesting otherwise.

Question 42

The answer is Option C

Explanation : Overconfidence holds here because John has been outperforming the market for several years and he's now becoming overconfident that he will do that again. Gambler's fallacy refers to the belief that one should buy a stock because there's a belief that the prolonged trend is likely to reverse at any second. This is true in our case as well since John is of the opinion that company is well managed, but just had bad luck recently. This is irrational and investing decisions should not be based on such irrationality. Confirmation bias is the tendency to search for and interpret information in a way that affirms one's prior beliefs. This can be seen when John tries to look for analyst reports which support his belief.