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Chapter 8
Behavioral Finance and the Psychology of Investing
Concept Questions
1. There are three trends at all times, the primary, secondary, and tertiary trends. For a market timer, the
2. A support area is a price or level below which a stock price or market index is not likely to drop. A
3. Mental accounting is when investors treat each investment separately as opposed to considering the
4. Plan participants often use the 1/n heuristic for their asset allocation. So, if someone allocates evenly
5. Men are generally more overconfident than women. This leads to excessive trading, which generally
6. The illusion of knowledge suggests that you believe the information you hold is better than that held
7. At the time the theory was developed, large companies in the U.S. were either involved in the
8. The least likely limit to arbitrage is firm-specific risk. For example, in the 3Com/Palm case, the
9. A contrarian investor goes against the crowd. For example, when investors are bullish, a contrarian
10. Consider support and resistance lines. If it is agreed the resistance line is $90, what would a rational
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
11. An up gap, where the low stock price today is higher than the high stock price from the previous day,
12. As long as it is a fair coin the probability in both cases is 50 percent as coins have no memory.
13. Prospect theory argues that investors are willing to take more risk to avoid the loss of a dollar than
they are to make a dollar profit. Also, if an investor has the choice between a sure gain and a gamble
14. Frame dependence is the argument that an investor’s choice is dependent on the way the question is
posed. An investor can frame a decision problem in broad terms (like wealth) or in narrow terms (like
15. A noise trader is someone whose trades are not based on information or financially meaningful
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
Core Questions
1. Adv./Dec. Cumulative
Monday 232 232
2. Arms ratio
Monday .967
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Education.
3. IBM AMZN
March $174.35 $600.17
April 183.08 581.42
4. IBM AMZN
March $177.24 $593.47
April 189.44 562.76
5. IBM AMZN
March $175.80 $596.82
April 186.26 572.09
May 192.33 547.23
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
6. MSI
1 .5207
If the MSI is used as a contrarian indicator, since the indicator is headed upward, the market appears
to be headed downward.
7
.Price Up/Down
Price times
Volume
Positive Money
Flow
Negative Money
Flow
Net Money
Flow
$70.12
$70.14 + 133,266 133,266
In this case, the money flow is a bearish signal.
8. Simple Exponential
10/1/15 - -
10/2/15 - -
10/5/15 1,954.08 1,970.56
The reason to calculate the moving average on an index is the same as for an individual stock. It can
9. There appears to be a support level at about $25. The resistance level may be about $30, although the
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
10. Adv./Dec. Cumulative Arms ratio
Monday 2,011 2,011 .545
Tuesday 1,790 3,801 .836
11. Price Up/Down
Price times
Volume
Positive Money
Flow
Negative Money
Flow
Net Money
Flow
$61.85
$61.81 - $61,810 $61,810
Since the price was relatively stable and the money flow was positive, this is likely a bullish signal.
Intermediate Questions
13. Day 3-day 5-day
1 - -
2 - -
3 39.60 -
4 40.07 -
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Education.
4 6 8 10 12 14 16
$39.20
$39.40
$39.60
$39.80
$40.00
$40.20
$40.40
$40.60
$40.80
$41.00
$41.20
14. Date 3-day 5-day
1- -
2- -
3 39.73 -
4 40.56 -
5 40.97 40.81
4 6 8 10 12 14 16
$39.00
$39.50
$40.00
$40.50
$41.00
$41.50
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Education.
15. Week Put/Call Ratio
1 1.1490
The put/call ratio is a measure of investor sentiment about the future direction of the market. Puts are
a bet that the market (or stock) will move down and calls are a bet the market (or stock) will move
upwards. The put/call ratio is the number of down bets divided by the number of up bets. A ratio
CFA Exam Review by Kaplan Schweser
1. a
2. c
3. a
4. c
5. c
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Education.
