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Psychology of Investing Chapter 5

Psychology of Investing Chapter 5 - correct answer Based on...

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How a question is worded or framed causes people to react differently. A negative framework will cause less people to choose the option while a positive framework with the same results will be chosen more frequently. The framework of an option is also combined with anchoring leads people to respond differently than when people do not have something to anchor on. Leverage is the use of debt in a business's capital structure, the more leverage use the more debt a company has and thus it is riskier. Firms with poor growth prospects are often identified by their high book-to-market (B/M) ratio. Intuitive mode is spontaneous and effortless compared to analytical which is deliberate and effortful. The prospect theory suggests people tend to take certain options in positive frame while risky ones in negative frames. The cognitive reflection test (CRT) reveals whether a person is an intuitive thinker or analytical thinker, an impulsive thinker will instantly give an answer while an analytical thinker will take time to determine the
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Unformatted text preview: correct answer. Based on a study by Shane Frederick, who created the CRT test, he found out that analytical thinkers and intuitive thinker will switch selections based on framework even with some results. People with opt-in pension plans or 401 k will have a higher percentage of not participating if they are overwhelmed with the amount of mutual funds offered. However, if people are automatically opted into a program, such as a 401 k, the participation rate is much higher when they have to opt out instead of having to opt in. This reveals how people are scared to research the various mutual funds to find one that matches their goals as a result of lack of knowledge, fear, or time. The study shows that with each additional ten mutual funds added onto the list of available choices, the percentage of people who choose to opt-in decreases by several percent....
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