978-1259720697 Chapter 8 Solution Manual

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

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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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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

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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

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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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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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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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