Tutorial 1 and 2 Answers.pdf - Tutorials 1: The behavioral...

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Tutorials 1: The behavioral finance perspectiveMimi Fong, CFA, a private wealth manager with an asset management firm, has been asked tomake a presentation to her colleagues comparing traditional and behavioral finance. She decidesto enliven her presentation with statements from colleagues and clients. These statements areintended to demonstrate some key aspects of and differences between traditional and behavioralfinance.Statement 1“When new information on a company becomes available, I adjust my expectationsfor that company’s stock based on past experiences with similar information.”(heuristic ratherthan Bayes)Statement 2“When considering investments, I have always liked using long option positions. Ilike their risk/return tradeoffs. My personal estimates of the probability of gains seem to behigher than that implied by the market prices. I am not sure how to explain that, but to me longoptions provide tremendous upside potential with little risk, given the low probability of limitedlosses.”(Prospect theory slide 24 to 26)Statement 3“I have always followed a budget and have been a disciplined saver for decades.Even in hard times when I had to reduce my usual discretionary spending(Non-essentialspending), I always managed tosave.”(expected utility theoryBayes theorem)Statement 4“While I try to make decisions analytically, I do believe the markets can be drivenby the emotions of others. So I have frequently used buy/sell signals when investing(technicalanomalies). Also, my 20 years of experience with managers who actively trade on suchinformation makes me think they are worth the fees they charge.”Statement 5“Most of my clients need a well-informed advisor to analyze investment choicesand to educate them on their opportunities. They prefer to be presented with three to six viablestrategies to achieve their goals. They like to be able to match their goals with specificinvestment allocations or layers of their portfolio.”(Mental accounting)Statement 6“I follow adisciplined approach to investing. When a stock has appreciated by 15percent, I sell it. Also, I sell a stock when its price has declined by 25 percent from my initialpurchase price.”(behavioral portfolio Theory)Statement 7“Overall, I have always been willing to take a small chance of losing up to 8percent of the portfolio annually. I can accept any asset classes to meet my financial goals if thisconstraint is considered. In other words, an acceptable portfolio will satisfy the followingcondition: Expected return1.645 x Expected standard deviation -8%.”(Slide 40traditionalperspective on portfolio construction)

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