Question

QUESTION 41

1. Sally Homes invested in a diversified portfolio of equities about 5 years ago. Overall, the performance has been in line with the market. However, Stock A, which Sally has always thought was a good company, has recently been handily outperforming the averages. Despite recent news articles and analyst reports indicating a potential slowdown in earnings, Sally moved an additional 5% of her portfolio into Stock A. Which of the following behavioral mistakes may she have made?

   		a. Representativeness.
   		b. Cognitive dissonance.
   		c. Irrational escalation.
   		d. Both b & c.

QUESTION 42

1. John Bell, a money manager at a large regional investment firm, has been outperforming the market for several years. He's considering a large investment in Stock Q because the company's last three product introductions sold poorly. He thinks the company is well managed, but just had bad luck recently. He sorted through several analyst reports and found two that support his opinion. If he buys the stock, which behavioral mistakes may he be making? (1) Overconfidence. (2) Anchoring. (3) Gambler's fallacy. (4) Confirmation bias.

   		a. 1 and 2.
   		b. 2 and 3.
   		c. 1, 3 and 4.
   		d. 1, 2, 3 and 4.

Answer 1

41: representativeness

This is the mistake made by investors in which they believe that the past performance is representative of the future performance of the company. Cognitive dissonance occurs when investors believes in two opposite things at the same time which is not the case. In case of irrational escalation, losing stocks are purchased.

42: 1.3 and 4

This is certainly a case of overconfidence which has arisen due to consistently outperforming the market. This does not represent anchoring since he has not used in relevant information to make the decision. This is also a case of gambler’s fallacy which makes him think that the gambles that he took will pay off repeatedly. This is also Confirmation bias since the reports are used to reconfirm his own beliefs.