Fundamentals of Corporate Finance, 12e (Ross)
Chapter 22 Behavioral Finance: Implications for Financial Management
1) Nadine made a business decision that turned out badly. In reflecting upon her decision, she
decided it was a reasoning error that led to the faulty decision. Which one of the following areas
of study best applies to this situation?
A) Corporate ethics
B) Financial statement analysis
C) Managerial finance
D) Debt management
E) Behavioral finance
2) Peter has successfully managed the finances of A.D. Leadbetter in a manner that has yielded
abnormally high returns. Due to this success, Peter has decided to publish a newsletter for
financial executives so that he can share his superior financial wisdom with others. There is a
very real probability that Peter has which one of the following characteristics?
A) Gambler’s fallacy
B) Frame dependence
C) Overconfidence
D) Representativeness heuristic
E) Sentiment-based risk attitudes
3) Jeremy believes he excels at picking stock winners and thus trades frequently. Which
characteristic does he most likely represent?
A) Confirmation bias
B) Frame dependence
C) Overconfidence
D) Representativeness heuristic
E) Break-even effect
4) Anytime Ted analyzes a proposed project, he always assigns a much higher probability of
success to the project than is warranted by the information he has gathered. Ted suffers from
which one of the following?
A) Frame dependence
B) Mental accounting
C) Endowment effect
D) Confirmation bias
E) Overoptimism
5) The tendency for a decision maker to search for reassurance that a recent decision he or she
made was a good decision represents which one of the following characteristics?
A) Overconfidence
B) Overoptimism
C) Affect heuristic
D) Confirmation bias
E) Representativeness heuristic
6) Which one of the following best illustrates an error which you, as a project manager, might
make due to confirmation bias?
A) Overestimating the best outcome expected from a project while underestimating the
possibility of a less favorable outcome
B) Assuming that a new project will be profitable since similar projects in the past were
successful
C) Assuming that your expectations of the future outcome from a project are more accurate than
the expectations of others within your organization
D) Listening to the advice of subordinates with whom you agree while ignoring the advice of
subordinates with whom you tend to disagree
E) Downplaying the cost of future failure of an existing project since the project has already paid
for itself
7) Assume you are an overconfident manager. You are most apt to do which one of the following
more so than you would if you were not overconfident?
A) Research a project more thoroughly before committing funds to commence it
B) Accept risky projects that turn out to be less profitable than you expected
C) Wait until new technology proves its worth before incorporating it into your firm’s operations
D) Avoid mergers and acquisitions
E) Invest excess company cash more conservatively than your peers at other firms
8) Marzella Corp. is analyzing a project that involves expanding the firm into a new product line.
The project’s financial projections will tend to have which one of the following characteristics if
the person compiling those projections suffers from overoptimism?
A) Overestimated construction costs
B) Overestimated expenses
C) Overestimated net present values
D) Underestimated profits
E) Underestimated sales estimates
9) Alice believes she can accurately forecast the future and makes business decisions based on
this belief. Which characteristics does this belief represent?
A) Overconfidence
B) Overoptimism
C) Affect heuristic
D) Confirmation bias
E) Representativeness heuristic
10) Kate tends to hold onto assets that have lost value in the hope that their values will increase
in the future. Kate illustrates which one of the following?
A) Frame dependence
B) Self-attribution bias
C) Gambler’s fallacy
D) Break-even effect
E) Regret aversion
11) Which one of the following refers to the fact that an individual may reply differently if a
question is asked in an equivalent but different manner?
A) Loss aversion
B) Gambler’s fallacy
C) Frame dependence
D) Overconfidence
E) Format reference
12) Aivree wants to accumulate great wealth but she invests all of her funds in U.S. Treasury
bills because she wants to avoid the potential losses she knows can occur in the stock markets.
Aivree best illustrates which one of these characteristics?
A) Loss aversion
B) Gambler’s fallacy
C) Disposition effect
D) Law of small numbers
E) Mental accounting
13) Consumer Marketing just conducted a two-phase survey. In the first phase, the survey
questions were worded such that the answers tended to sound positive. In the second phase, the
survey questions were reworded so the answers tended to convey a negative feeling. Both sets of
survey questions should have resulted in similar results as the information solicited was
essentially identical. However, the survey results varied significantly. This survey best illustrates
which one of the following?
A) Mental accounting
B) Overconfidence
C) Self-attribution bias
D) Confirmation bias
E) Frame dependence
14) Recently, a neighbor you have known for years won a lottery and received a $250,000 prize.
This neighbor decided to invest all of his winnings in a new business venture that he knew only
had a 5 percent chance of success. Previous to this, the neighbor had always been ultra
conservative with his money and had refused to invest in this business venture as recently as last
week. Which one of the following behaviors most applies to your neighbor’s decision to invest in
this business venture now?
A) Disposition effect
B) Affect heuristic
C) Gambler’s fallacy
D) House money
E) Get-evenitis
15) The tendency to sell winners and hold losers is known as the:
A) representativeness heuristic.
B) disposition effect.
C) house money effect.
D) self-attribution bias.
E) affect heuristic.
16) Steve purchased a stock last year for $34 a share. The stock increased in value to $36 a share
before declining to its current value of $30. Steve has decided to sell the stock, but only if he can
receive $34 a share or better. Steve is primarily suffering from which one of the following
behavioral conditions?
A) Representativeness heuristic
B) House money
C) Loss aversion
D) Randomness
E) Myopic loss aversion
17) Over the past six months, you have watched as your parent’s retirement savings have
declined in value by 25 percent due to a severe financial market downturn. As a result, you have
decided that you will never invest in stocks for your own retirement but will instead keep all of
your money in an insured bank account. Which behavioral characteristic have you acquired as a
result of the market downturn?
A) Myopic loss aversion
B) Get-evenitis
C) Self-attribution bias
D) Mental accounting
E) Regret aversion
18) Ramon opened a combination laundry and dry cleaning establishment three years ago that is
quite successful. He has considered expanding this business by opening another location but
keeps putting off that decision for fear that the second location will not be a success. Ramon is
currently displaying which one of the following behavioral characteristics?
A) Self-attribution bias
B) Overconfidence
C) Regret aversion
D) House money effect
E) Frame dependence
19) Phyllis is planning for her retirement in 15 years. She currently lives comfortably on $38,000
a year given that she is debt-free. Based on her family history she only expects to live ten years
after she retires. Thus, she computes her retirement need as $38,000 a year for ten years. Which
one of the following behaviors applies to Phyllis?
A) Regret aversion
B) Money illusion
C) Self-attribution bias
D) Endowment effect
E) Myopic loss aversion
20) Kate is attempting to sell her house for $260,000. Fred lives across the street in an identical
house. Fred recently stated to his wife that Kate’s house is probably worth only $250,000 but that
once she sells her house, he would like to put their house on the market at $285,000 and then
move into a condominium. Which one of the following behaviors applies to Fred?
A) Myopic loss aversion
B) House money effect
C) Money illusion
D) Self-attribution bias
E) Endowment effect
21) You have a tendency to take credit for the decisions you make that have good outcomes even
when those outcomes are out of your control. On the other hand, you blame bad luck for your
decisions that turn out badly. Which of these terms applies to you?
A) Myopic loss aversion
B) House money effect
C) Money illusion
D) Self-attribution bias
E) Endowment effect
22) A tendency to be overly conservative when faced with new information is referred to as:
A) anchoring and adjustment.
B) heuristics.
C) self-attribution.
D) loss aversion.
E) regret aversion.
23) Bill feels that he possesses a good dose of “street smarts.” Thus, he makes his business
decisions based on how a project feels to him rather than taking the time to financially analyze a
project. This type of behavior is referred to as:
A) overconfidence.
B) endowment effect.
C) money illusion.
D) affect heuristic.
E) sentiment-based risk.
24) Which term refers to the tendency to shy away from the unknown?
A) Aversion to ambiguity
B) Clustering illusion
C) Anchoring and adjustment
D) Recency bias
E) Availability bias