Behavioral Finance Fundamentals

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Correct Answer

Partially Correct

Incorrect Answer

Which of the following is not a tenet of behavioral finance?

Your Answer

Investors are rational

Correct Answer
Investors are rational

Explanation
Modern finance assumes that investors are rational. On the contrary, behavioral finance assumes that
investors are not perfectly rational.

George buys a car by carefully weighing all the options about fuel consumption, performance, safety
features, price, etc. This is an example of ________.

Your Answer

Reflective decision making

Correct Answer

Reflective decision making

Explanation
By carefully gathering information, weighing choices and then finally making the decision, George is
engaged in reflective decision making.

Lucy buys a car because it is that specific shade of red that she loves. This is an example of ________.

Your Answer

Reflexive decision making

Correct Answer

Reflexive decision making

Explanation
By using emotion or intuition to make decisions, Lucy is engaged in reflexive decision making.

In a survey, Ian ranked himself better than average, while more than half of the people also ranked
themselves as better than average. This is an example of ________.

Your Answer

Overconfidence bias

Correct Answer
Overconfidence bias

Explanation
It is impossible for more than half the people to believe they are better than average, so people who do
think they are above average may be susceptible to overconfidence bias.

When building her portfolio, Erica gathered all possible information available to the public of stock A.
Based on that information, she decided to buy it. She believes that her decision must be correct. This is
an example of ________.

Your Answer

Illusion of knowledge

Correct Answer

Illusion of knowledge

Explanation
By believing that more knowledge can help make better decisions, Erica is susceptible to the illusion of
knowledge.

Kristen believes that if she wears her lucky green socks, the stock market will go up today. This is an
example of ________.

Your Answer

Illusion of control

Correct Answer

Illusion of control

Explanation
By believing that some actions can influence the outcome of unrelated events, Kristen is susceptible to
the illusion of control.

David gained on his portfolio. He believes that it is purely because of his superior skills. This is an
example of ________.

Your Answer
Self-attribution bias

Correct Answer

Self-attribution bias

Explanation
By believing that a gain in his portfolio is purely a result of his skills not partially good luck, David is
susceptible to self-attribution.

Stock B crashed. Brad, who bought the stock a few days ago, claimed that there were glaring indicators
that this stock was about to crash. This is an example of ________.

Your Answer

Hindsight bias

Correct Answer

Hindsight bias

Explanation
By believing that something could be predicted ahead of time when it could not, Brad is susceptible to
hindsight bias.

Mary believes that stock C will go up. She finds evidence that their financial statements reported a 20%
increase in revenue, while ignoring less optimistic evidence. This is an example of ________.

Your Answer

Confirmation bias

Correct Answer

Confirmation bias

Explanation
By concentrating on evidence that supports her beliefs and ignoring evidence that contracts her beliefs,
Mary is susceptible to confirmation bias.

10

Stocks D and E are positively correlated. Carl believes that it is that the likelihood of D and E both going
up is higher than the likelihood of D going up. This is an example of ________.
Your Answer

Representative bias

Correct Answer

Representative bias

Explanation
By judging possibilities based on how they appear and not analyzing them, Carl is susceptible to
representative bias.

11

Heather prefers a 60% chance of winning compared to 40% chance of losing. This is an example of
________.

Your Answer

Loss aversion

Correct Answer

Framing bias

Explanation
By prefering the choice phrased as winning although both are equal, Heather is susceptible to framing
bias.

12

Nancy went shopping. The dress on the foremost display is priced at $2,000. She walks further in and
finds a dress marked as $1,000. She finds the price of $1,000 acceptable because it is less expensive than
$2,000. This is an example of ________.

Your Answer

Anchoring bias

Correct Answer

Anchoring bias

Explanation
By preparing customers' mind using an extremely high price and making them feel that a lower but yet
still expensive price is reasonable, the store is successfully employing the anchoring bias.

13
Amy, who is the HR recruiting manager, interviews 2 candidates. One talks about being a capable,
responsible banker with prior work experience; the other talks about interesting childhood stories. Amy
develops a liking for the second candidate. This is an example of ________.

Your Answer

Narrative fallacy

Correct Answer

Narrative fallacy

Explanation
By prefering stories to the point of ignoring the facts and evidence, Amy is susceptible to narrative
fallacy.

14

John, after seeing a lot of investors invest in stock F, decides to invest in stock F himself. This is an
example of ________.

Your Answer

Herding effect

Correct Answer

Herding effect

Explanation
By following the lead of others, John is susceptible to the herding effect.

15

There is a half-half chance for Francis to gain $5,000 or lose $3,000. Francis refuses the opportunity
because he thinks it is too risky. This is an example of ________.

Your Answer

Loss aversion

Correct Answer

Loss aversion

Explanation
By avoiding the loss even though the expected value of the opportunity is positive, the emotional
negativity caused by the loss is greater than the emotional positivity than the gain, thus Francis is
susceptible to loss aversion.
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