CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz item set answers, study session 3, reading 6
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Reading 6
The Behavioral Biases of Individuals
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CFA Level III Item-set - Solution
Study Session 3
June 2018
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Reading 6
The Behavioral Biases of Individuals
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FinQuiz Level III 2018 – Item-sets Solution
Reading 6: The Behavioral Biases of Individuals
1. Question ID: 16911
Correct Answer: B
Walter is subject to the confirmation bias since he has established screening criteria, and is ignoring
information that is refuting the validity of the criteria. This is evident from the fact that Walter is
ignoring the investment recommendation made by Bright just because the investment does not meet
the screening criteria (and more so, challenges the validity of his criteria).
2. Question ID: 16912
Correct Answer: B
In his comment, Walter has stated that it would not be wise to update beliefs about the company’s
future performance by processing the new information. The effort involved in such updating is termed
as cognitive cost. Not updating beliefs just to avoid cognitive costs can lead to the conservatism bias
(maintaining a prior belief).
Walter is not subject to the representative bias because he has not updated his beliefs upon learning of
the expected lower future growth rate. Investors subject to the representative bias update their beliefs
by using simple classifications rather than dealing with the pressure of interpreting complex data.
3. Question ID: 16913
Correct Answer: C
The confirmation bias and the illusion of control bias can lead to inadequately diversified portfolios
and excessive exposure to risk.
4. Question ID: 16914
Correct Answer: A
The representativeness bias and the illusion of control bias can lead to excessive trading and inferior
performance results.
5. Question ID: 16915
Correct Answer: C
Statement 1 is correct. Individuals subject to the conservatism bias tend to overweight the base rates,
and those subject to the representativeness bias tend to underweight the base rates.
Statement 2 is correct. A useful step in correcting for the confirmation bias is to get corroborating
support for an investment decision.
6. Question ID: 16916
Correct Answer: C
Buying into a fund after a rapid price appreciation indicates a focus on short-term results and is due to
the representativeness bias.
7. Question ID: 17019
Correct Answer: C
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Reading 6
The Behavioral Biases of Individuals
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Turner is subject to representativeness bias. She is making all her new investments based on the
apparent similarities of the stocks with the stock of Agri-Group (a successful investment) without
doing research to validate the new investment’s merits. She thinks that the stock’s characteristics are
representative of successful companies’ stocks.
8. Question ID: 17020
Correct Answer: B
Regret aversion can lead investors to hold on to investments too long. Even though the stock’s price
has reached the target Brown set for it, he is still reluctant to sell because he fears that the position
will increase in value even more and then he will regret having sold it.
9. Question ID: 17021
Correct Answer: A
Given the low turnover and low frequency of trading, the client seems to be subject to status-quo bias.
The low frequency of trading seems unintentional (like in a state of inertia), since when Turner
brought the issue to the client’s attention, he asked her to sell off all investments that had gained
immediately. This also demonstrates his loss aversion—he wants to sell profitable investments as
soon as possible to realize the gains (a concept also known as the disposition effect).
10. Question ID: 17022
Correct Answer: B
Turner is referring to self-attribution bias and herding behavior. Individuals who are overconfident
are generally also the victims of self-attribution bias; a bias which boosts their self-esteem and
relieves them of personal responsibility for failures. Regret-aversion bias can be responsible for
initiating herding behavior: the tendency to go with the crowd in order to avoid the future regret of
making an unconventional, poor decision.
11. Question ID: 17023
Correct Answer: B
Client A is subject to availability bias and Client B is subject to loss aversion bias. Since availability
bias is a cognitive bias, and loss aversion is an emotional bias, given a high level of wealth and low
standard of living risk, Client B’s bias should be adapted to, and Client A’s bias should be moderated
and adapted to.
12. Question ID: 17024
Correct Answer: C
Brown is subject to regret aversion bias. This bias has led to the preference of White Inc.’s stock,
even though the risk and return expectations of both stocks are equal. By investing in a stock that is
backed by well-known institutional investors, Brown is trying to avoid the burden of responsibility of
making a poor decision. This in turn will reduce the pain of regret he would feel (it seems safe to be
with the crowd).
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