Fundamentals of Investments Valuation and Management 7th Edition Jordan Test Bank

Fundamentals of Investments Valuation
and Management 7th Edition Jordan

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Chapter 08
Behavioral Finance and the Psychology of Investing
Multiple Choice Questions
1. What is the area of finance called that addresses issues such as how reasoning errors affect
investment decisions?
A. logical
B. individual
C. behavioral
D. rational
E. personal
2. Which one of the following is the basis for prospect theory?
A. Investors react differently to prospective gains and losses.

B. Investors make cognitive errors.
C. Some investors are irrational.
D. Investors react differently depending on the day of the week.
E. Investors suffer from money illusion.
3. Which one of the following defines frame dependence?

B. Investors tend to make more cognitive errors when they view investing as gambling.
C. Investors tend to be more irrational in bear markets than in bull markets.
D. Investors react differently depending on how an opportunity is presented.
E. Investors suffer from money illusion in bull markets but not in bear markets.
8-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
4. Mental accounting is the process of associating a stock with its:
A. prior day's market value.

B. expected value.
C. desired value.
D. purchase price.
E. lowest value.
5. Loss aversion is defined as:
A. the inability to mentally acknowledge a loss on a security.

B. selling any security for less than the price paid to acquire it.
C. selling a security as soon as it has increased significantly in value.
D. the reluctance to sell a security after it has decreased in value.
E. the tendency to quickly sell any investment that has decreased in value.
6. Representativeness heuristic is best explained as:
A. the process of assuming events are random even when they are not.
B. the creation of patterns in planned events.
C. concluding that casual factors cause random events when in fact they do not.
D. believing that random events that occur in clusters are truly random.
E. overconfidence in one's own skills as an investor.
7. The belief that information you hold is superior to information held by other investors best
describes:
A. over-confidence
B. the snakebite effect
C. the illusion of knowledge
D. the clustering illusion
E. loss aversion
8-2
8. An unwillingness to take a risk after a loss describes:
A. over-confidence
E. loss aversion
9. Which one of the following is the tendency to believe that random events that occur in
clusters are not really random?
A. clustering illusion
B. sequential clustering
C. random grouping
D. representativeness heuristic
E. gambler's fallacy
10. Which one of the following best describes heuristics?
A. clustering
B. rules of thumb
C. grouping
D. representativeness
E. herding
11. The concept that well-capitalized, rational traders may be unable to correct a mispricing
defines which one of the following terms?
A. noise trading bounds

B. market bounds
C. limits to arbitrage
D. implementation limits
E. sentiment borders
8-3
12. Which one of the following is a trader whose trades are not based on meaningful financial
analysis or information?
A. specialist
B. arbitrageur
C. noise trader
D. sentiment trader
E. market maker
13. Which one of the following risks is related to irrational beliefs?
A. systematic
B. firm-specific
C. industry-specific
D. sentiment-based
E. market
14. Technical analysis is the study of which one of the following as the basis for trading?
A. systematic risk
B. historical prices
C. dividend growth
D. financial statements
E. investor's required return
8-4
15. Dow theory is a method of predicting future market movements based on which of the
following Dow Jones averages?
I. industrial
II. transportation
III. utilities
IV. commodities
A. I and II only
B. II and III only
C. III and IV only
D. I and IV only
E. I, II, and III only
16. According to Elliott wave theory, market predictions should be based on which one of the
following?
A. eight-week repetitive trading patterns

B. the tidal waves created by the gravitational pull of the moon
C. series of historical market price swings
D. an industry's historical rate of growth
E. market fads and trends
17. The minimum price at which a security is expected to trade is called the:
A. stop value.
B. par value.
C. Elliott wave price.
D. resistance level.
E. support level.
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18. The maximum price at which a security is expected to trade is called the:
A. fourth wave.
B. stop limit.
C. relative point.
E. support level.
19. The measure of performance of one investment compared to another investment is called
the:
A. wave height.
B. relative arm.
C. relative strength.
D. bar height.
E. support factor.
20. Prospect theory is based on the concept that investors are:
A. always risk takers.

B. risk-adverse regarding losses.
C. risk-taking regarding losses.
D. always risk-averse.
E. neutral regarding risk.
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21. Which one of the following statements is correct regarding prospect theory?
A. Average investors tend to lose more money than they earn from investing.
B. Typical investors feel that losing $1 is twice as painful as the pleasure derived from
making $1.
C. Investors should focus on gains and losses in individual securities rather than their
portfolio's total value.
D. Typical investors tend to react irrationally only when focusing on total portfolio value.
E. Average investors tend to prefer higher levels of risk.
22. Phil is a contestant on a game show. At this point in the game, he can either accept $500 or
spin a wheel for a chance of winning $100,000. Which type of behavior is he displaying if he
spins the wheel?
A. forward-looking
B. risk-adverse
C. prospective
D. introspective
E. risk-taking
23. Investors tend to make better decisions when looking at a decision:
A. based on historical performance.

B. only in respect to potential losses.
C. based on individual securities.
D. in broad terms.
E. based on historical costs.
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24. Which one of the following is an example of mental accounting?
A. associating a security's gains or losses based on its purchase price

B. calculating the gain or loss on a security on a daily basis
C. computing the amount of tax due on the gain from a stock sale
D. considering the gain realized when a stock pays a dividend
E. comparing the gains and losses on a portfolio to those of the overall market
25. According to the concept of loss aversion, individual investors are most apt to do which one
of the following?
A. sell stocks with gains more frequently than stocks with losses
B. sell stocks with losses more frequently than stocks with gains
C. hold stocks with gains and sell stocks with losses
D. sell all stocks after a pre-determined length of time
E. hold all stocks unless they decline more than ten percent in value
26. According to the concept of house money, individual investors are most apt to do which one
of the following?
A. take more risks with their initial investment than with the gains on that investment
B. value money differently depending upon its source
C. treat paper profits the same as initial cash investments
D. apply the same level of risk-aversion to all investments
E. place high value on paper profits but low value on paper losses
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27. Peter hesitates when it comes to picking an individual stock to purchase as he feels that he
will later realize that a different stock would have been a better investment. Peter is suffering
from:
A. money illusion.
B. frame dependence.
C. regret aversion.
D. risk-taking.
E. mental accounting.
28. The tendency to overvalue an item because you own it is referred to as which one of the
following?
A. endowment effect
B. money illusion
C. regret aversion
D. myopic loss aversion
E. sunk cost fallacy
29. Yesterday, Krista stated that Overland stock was only worth $12 a share and since it was
selling for $15 a share, she declared it overpriced and refused to buy any shares. This
morning, she learned that she is inheriting 3,500 shares of Overland stock from her
grandmother. Suddenly, she is saying that Overland stock is a great buy at $15 and is
probably worth at least $17 a share. This is an example of which one of the following?
A. endowment effect
B. money illusion
C. regret aversion
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30. Ted constantly ignores the effects of inflation on money. Ted is suffering from which one of
the following?
A. endowment effect
B. money illusion
C. regret aversion
31. Investors who tend to invest too heavily in the securities issued by their employer suffer from
the condition known as:
A. overconfidence.
B. loyalty adherence.
C. status quo.
D. local adhesion.
E. familiarity.
32. Which one of the following statements appears to be correct based on current research?
A. Single, female investors tend to earn lower returns than their male counterparts.
B. Overconfidence tends to result in lower returns.
C. Excessive trading tends to increase returns.
D. Men tend to trade less frequently than women.
E. Investors with higher incomes tend to be more risk-adverse than other investors.
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33. The increased cash flows into mutual funds that have recently had superior returns is most
associated with which one of the following characteristics?
A. overconfidence
B. excess trading
C. clustering illusion
D. diversification
E. risk aversion
34. Tricia has lost money on a particular stock for the past three years. Thus, she believes the
stock will have a high positive rate of return this year because earning a good return is long
overdue. This assumption is best described as the:
A. law of small numbers.

B. house money effect.
C. gambler's fallacy.
D. false consensus.
E. recency bias.
35. Four of the last five stocks your investment adviser recommended have outperformed the
market.
Thus, you believe that if you continue to follow her advice, that 80 percent of your
investments will outperform the market over the long term. This belief is based on the:
A. gambler's fallacy.
B. law of small numbers.
C. law of large numbers.
D. clustering illusion.
E. positive performance illusion.
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36. According to the theory of recency bias, investors tend to believe the financial markets will:
A. gravitate to their long-term average rates of return.

B. react over the next year in direct opposition to the performance of the prior year.
C. have a maximum of three years of positive annual returns before declining somewhat.
D. continue to perform as they have over the past couple of years.
E. tend to reverse direction at least every five years.
37. Which one of the following is a characteristic of the self-attribution bias?
A. believing what you wish to believe

B. placing too much weight on information which you can gather easily
C. believing that other investors agree with your thinking
D. taking credit for the wins and blaming the losses on bad luck
E. believing that your recent performance is an indication of your future performance
38. Which of the following are impediments to the correction of a security's mispricing?
I. sentiment-based risk
II. implementation costs
III. firm-specific risk
IV. noise trader risk
A. II only
B. II and IV only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV
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39. Which one of the following market sentiment index (MSI) values represents the best buying
opportunity?
A. 0.16
B. 0.29
C. 0.48
D. 0.61
E. 0.82
40. Which one of the following market sentiment index (MSI) values indicates that all polled
investors were bearish?
A. -1
B. 0
C. 1
D. 50
E. 100
41. Which one of the following indicates the long-run direction of the market according to Dow
Theory?
A. daily fluctuations
B. secondary reaction
C. monthly changes
D. primary trend
E. tertiary trend
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42. What is the primary purpose of Dow theory?
A. to measure the level of investor optimism and pessimism

B. to analyze daily market movements
C. to identify and measure market waves
D. to eliminate market corrections
E. to signal changes in the market's primary direction
43. According to Dow theory, which one of the following is the primary means of eliminating
secondary market trends?
A. corrections
B. confirmations
C. continuations
D. conversions
E. coordinated trades
44. If you are a proponent of the Elliott wave theory, you are most apt to do which one of the
following?
A. sell on wave 2
B. sell on wave 3
C. buy on wave A
D. buy on wave 2
E. buy on wave 5
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45. According to technical analysis, which one of the following is best seen as a buying
opportunity?
A. a breakout of a resistance level

B. an MSI value of 0.1 or less
C. a downward sloping advance/decline line
D. a flat advance/decline line
E. top of Elliott wave 5
46. You recently heard a news announcer state that the market is approaching its support level.
Which one of the following is the best interpretation of that statement?
A. The market is approaching the lowest level that is reasonably expected.

B. The federal government will step in to help the market retain its value should the market
slip much further.
C. The market is almost at a peak and is expected to start declining in the near future.
D. The market is almost to the point where trading will be suspended temporarily.
E. The market is almost equivalent in value to the international markets so price stabilization
is expected.
47. Which one of the following advance/decline lines is the most bullish signal?
A. relatively flat
B. slightly upward sloping
C. slightly downward sloping
D. steeply upward sloping
E. steeply downward sloping
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48. Which of the following are bullish indicators?
I. flat advance/decline line

II. breakout of a support level
III. Arms ratio of .38
IV. heavy advancing volume
A. I and II only
B. III and IV only
C. I and III only
D. II and III only
E. I and IV only
49. If the closing tick of the day is +32, this means that the:
A. DJIA ended the day up 32 basis points.

B. discount rate at the end of the day was 3.20 percent.
C. number of stocks closing on an uptick was 32.
D. number of stocks closing on an uptick exceeded those closing on a downtick by 32.
E. number of stocks closing on an uptick was 32 more than on the prior trading day.
50. Which one of the following Arms values is the most bearish?
A. .28
B. .45
C. .88
D. 1.03
E. 1.26
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51. For the past year, a particular stock has a relative strength value of 1.03 as compared to the
market. This means that the stock:
A. increased in value 3 percent more than the market for the day.
B. has 3 percent more risk than the average security.
C. outperformed the market for the period.
D. had 3 percent higher trading volume on a growth basis as compared to the market.
E. is selling for 103 percent of the market value per share.
52. A "block trade" is a trade in excess of how many shares?
A. 1,000
B. 5,000
C. 10,000
D. 50,000
E. 100,000
53. Which one of the following statements is correct concerning an open-high-low-close bar
chart?
A. The prices indicated by the two horizontal lines are the maximum and minimum daily
prices.
B. The upper trendline indicates the support level.
C. If the overall price movement is downward, the lower trendline is called the channel line.
D. If the overall price movement is upward, the upper trendline is called the head line.
E. The final price of the day is indicated by a horizontal line to the left side of the vertical line.
8-17
54. According to technical analysts, pricing patterns such as the head and shoulders are
indicators of potential:
A. reversals from the main trend line.

B. upcoming corrections which will return the market to the current main trend line.
C. increasing strength for the main trend line.
D. decreasing market activity.
E. increasing market activity.
55. Which one of the following is correct concerning a head and shoulders top pattern?
A. The outside of the right shoulder is a bullish signal.

B. The shoulders are higher than the head.
C. The left shoulder must be higher than the right shoulder, but lower than the head.
D. A piercing of the neckline is a reversal signal.
E. The trendline must be relatively flat throughout the pattern.
56. Which one of the following statements is correct regarding moving averages?
A. The 50-day moving average reflects the long-term trend of the market.
B. An exponential moving average is a weighted average.
C. Moving averages are used primarily to measure trading volume.
D. Short-term and long-term moving averages always move in the same direction.
E. Moving averages are generally computed using average daily prices.
8-18
57. Assume the 50-day moving average is currently intersecting the 200-day moving average.
Also assume the 50-day average is downward sloping and the 200-day average is upward
sloping. Which one of the following statements is accurate based on this information?
A. The 50-day moving average is bullish.

B. The short-term forecast is bullish.
C. The long-term trend may be preparing to change.
D. The long-term outlook is bearish.
E. The short-term trend will change to match the long-term trend.
58. Bollinger bands:
A. graphically reflect the differences between two moving averages.

B. graphically depict the relative strength of a security as compared to the market.
C. are a graphical representation of an exponential moving average.
D. depict a 2-standard deviation bound around a moving average.
E. are equal to the 20-day moving average plus or minus one standard deviation.
59. A stock's price has been relatively constant for an extended period of time. In this instance,
the Bollinger bands are:
A. relatively close to each other.

B. non-existent.
C. vertical.
D. steeply upsloping.
E. steeply downsloping.
8-19
60. Investors who use the MACD indicator as a signal for trading are most apt to buy a security
when the MACD:
A. equals zero.
B. is equal to 1.0.
C. rises above the signal line.
D. parallels the signal line.
E. falls below the signal line.
61. Which of the following are considered in the computation of money flows?
I. last trade price

II. current trade price
III. volume of each trade
IV. time of each trade
A. I and IV only
B. II and III only
C. I, II, and III only
62. Assume a stock's price remains relatively stable while the money flow becomes highly
positive. Which one of the following is most expected given this scenario?
A. price decrease
B. stable price
C. price increase
D. increasing trading volume
E. decreasing trading volume
8-20
63. Fibonacci numbers:
A. are all odd numbers of increasing value.

B. result in a golden mean which has an approximate value of 1.618.
C. are the square roots of the products of the two previous numbers in the series.
D. result in a phi which is approximately equal to .382.
E. are a series of numbers which are equal to the product of the two previous numbers.
64. Some technical analysts use Fibonacci numbers to predict:
A. primary trend breakthroughs.

B. market turnarounds.
C. secondary market trend lines.
D. relative performance values.
E. resistance and support levels.
65. Which one of the following is seen as a bearish indicator?
A. decreased short selling

B. increased buying by odd-lot traders
C. shorter skirt lengths
D. a Super Bowl win by a National Football League team
E. tight Bollinger bands
66. A survey of 64 of your fellow classmates determines that 19 of them are bullish on the market
while the remainder is bearish. What is the market sentiment index for this group of
individuals?
A. .28
B. .33
C. .44
D. .58
E. .70
8-21
67. A recent survey indicates that 1,731 people are bearish on the market for every 1,000 that are
bullish. What is the value of the market sentiment index based on this information?
A. .36
B. .43
C. .57
D. .63
E. .75
68. Given the following information, what is the value of the advance/decline line on the third day
of this 3-day period?
A. -277
B. -198
C. +202
D. +326
E. +409
8-22
69. Given the following information, what is the value of the advance/decline line on the second
day of this 3-day period?
A. -889
B. -804
C. -294
D. +147
E. +402
70. Given the following information, what is the value of the closing Arms?
A. .82
B. .84
C. .92
D. 1.11
E. 1.22
8-23
A. 0.29
B. 0.36
C. 0.42
D. 2.81
E. 3.45
72. Last year, Kathy purchased 3 shares of stock A at $50 a share. At the same time, she
purchased 5 shares of stock B at $35 a share. Today, stock A is valued at $65 a share and
stock B is worth $42 a share. What is the relative strength of stock A as compared to stock
B?
A. .84
B. .88
C. .93
D. 1.04
E. 1.14
8-24
73. What is the 3-day simple moving average as of day 5, given the following information?
A. $35.28
B. $35.35
C. $35.41
D. $35.57
E. $35.62
A. $42.88
B. $43.13
C. $43.22
D. $43.31
E. $44.61
8-25
75. What is the 3-day exponential moving average as of day 4 assuming that a weight of 70
percent is placed on the most recent price?
A. $50.81
B. $50.84
C. $50.87
D. $50.90
E. $50.94
A. $39.04
B. $39.07
C. $39.13
D. $39.22
E. $39.28
8-26
77. Given the following information, what is the net money flow at the end of the trading day?
A. -213,500
B. -103,000
C. 91,200
D. 187,600
E. 257,800
A. -290,500
B. -85,100
C. 322,200
D. 235,000
E. 421,400
8-27
79. The series of Fibonacci numbers contains the sequential values of 610 and 987. What is the
next number in this series?
A. 1,264
B. 1,364
C. 1,419
D. 1,597
E. 1,633
80. The price of a stock increased from $32 to $38. Using phi, what are the primary and
secondary support areas for the stock?
A. $35.33; $33.67
B. $33.67; $35.33
C. $35.71; $34.29
D. $38.14; $36.99
E. $36.99; $38.14
81. Altoona Train stock increased from $18 a share to $25 a share. Based on phi, what are the
primary and secondary support areas for this stock?
A. $21.46; $19.19
B. $21.67; $20.38
C. $21.79; $20.11
D. $22.12; $20.58
E. $22.33; $20.67
8-28
Essay Questions
82. Draw a basic Elliott Wave Pattern. Identify each wave and indicate the waves that are
"corrective" and those that are "impulsive".
83. Explain the basics of prospect theory and provide an example that illustrates this theory.
84. Give some examples of how overconfidence affects investor behavior along with the results
that might be expected based on that behavior.
8-29
Chapter 08 Behavioral Finance and the Psychology of Investing
Answer Key
Multiple Choice Questions
1. What is the area of finance called that addresses issues such as how reasoning errors
affect investment decisions?
A. logical
B. individual
C. behavioral
D. rational
E. personal
See Section 8.1
Accessibility: Keyboard Navigation

Blooms: Remember
Learning Objective: 08-01 Prospect theory.
Level of Difficulty: 1 Easy
Section: 8.1
Topic: Behavioral finance
2. Which one of the following is the basis for prospect theory?

B. Investors make cognitive errors.
C. Some investors are irrational.
D. Investors react differently depending on the day of the week.
E. Investors suffer from money illusion.
See Section 8.2
8-30
Blooms: Remember
Section: 8.2
Topic: Prospect theory
3. Which one of the following defines frame dependence?

B. Investors tend to make more cognitive errors when they view investing as gambling.
C. Investors tend to be more irrational in bear markets than in bull markets.
D. Investors react differently depending on how an opportunity is presented.
E. Investors suffer from money illusion in bull markets but not in bear markets.
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Frame Dependence
4. Mental accounting is the process of associating a stock with its:
A. prior day's market value.

B. expected value.
C. desired value.
D. purchase price.
E. lowest value.
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Mental Accounting
8-31
5. Loss aversion is defined as:
A. the inability to mentally acknowledge a loss on a security.

B. selling any security for less than the price paid to acquire it.
C. selling a security as soon as it has increased significantly in value.
D. the reluctance to sell a security after it has decreased in value.
E. the tendency to quickly sell any investment that has decreased in value.
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Loss Aversion
6. Representativeness heuristic is best explained as:
A. the process of assuming events are random even when they are not.
B. the creation of patterns in planned events.
C. concluding that casual factors cause random events when in fact they do not.
D. believing that random events that occur in clusters are truly random.
E. overconfidence in one's own skills as an investor.
See Section 8.4

Blooms: Remember
Learning Objective: 08-02 The implications of investor overconfidence and misperceptions of randomness.
Section: 8.4
Topic: Representativeness Heuristic
8-32
7. The belief that information you hold is superior to information held by other investors best
describes:
A. over-confidence
E. loss aversion
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Illusion of Knowledge
8. An unwillingness to take a risk after a loss describes:
A. over-confidence
E. loss aversion
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Snakebite Effect
8-33
9. Which one of the following is the tendency to believe that random events that occur in
clusters are not really random?
A. clustering illusion
B. sequential clustering
C. random grouping
D. representativeness heuristic
E. gambler's fallacy
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Clustering Illusion
10. Which one of the following best describes heuristics?
A. clustering
B. rules of thumb
C. grouping
D. representativeness
E. herding
See Section 8.5

Blooms: Remember
Section: 8.5
Topic: Heuristics
8-34
11. The concept that well-capitalized, rational traders may be unable to correct a mispricing
defines which one of the following terms?
A. noise trading bounds

B. market bounds
C. limits to arbitrage
D. implementation limits
E. sentiment borders
See Section 8.6

Blooms: Remember
Learning Objective: 08-03 Sentiment-based risk and limits to arbitrage.
Section: 8.6
Topic: Limits to Arbitrage
12. Which one of the following is a trader whose trades are not based on meaningful financial
analysis or information?
A. specialist
B. arbitrageur
C. noise trader
D. sentiment trader
E. market maker
See Section 8.6

Blooms: Remember
Section: 8.6
Topic: Noise Trader
8-35
13. Which one of the following risks is related to irrational beliefs?
A. systematic
B. firm-specific
C. industry-specific
D. sentiment-based
E. market
See Section 8.6

Blooms: Remember
Section: 8.6
Topic: Sentiment-Based Risk
14. Technical analysis is the study of which one of the following as the basis for trading?
A. systematic risk
B. historical prices
C. dividend growth
D. financial statements
E. investor's required return
See Section 8.7

Blooms: Remember
Learning Objective: 08-04 The wide array of technical analysis methods used by investors.
Section: 8.7
Topic: Technical Analysis
8-36
15. Dow theory is a method of predicting future market movements based on which of the
following Dow Jones averages?
I. industrial
II. transportation
III. utilities
IV. commodities
A. I and II only
B. II and III only
C. III and IV only
D. I and IV only
E. I, II, and III only
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Dow Theory
16. According to Elliott wave theory, market predictions should be based on which one of the
following?
A. eight-week repetitive trading patterns

B. the tidal waves created by the gravitational pull of the moon
C. series of historical market price swings
D. an industry's historical rate of growth
E. market fads and trends
See Section 8.7

Blooms: Remember
8-37
Section: 8.7
Topic: Elliott Wave Theory
17. The minimum price at which a security is expected to trade is called the:
A. stop value.
B. par value.
C. Elliott wave price.
E. support level.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Support Level
18. The maximum price at which a security is expected to trade is called the:
A. fourth wave.
B. stop limit.
C. relative point.
E. support level.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Resistance Level
8-38
19. The measure of performance of one investment compared to another investment is called
the:
A. wave height.
B. relative arm.
C. relative strength.
D. bar height.
E. support factor.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Relative Strength
20. Prospect theory is based on the concept that investors are:
A. always risk takers.

B. risk-adverse regarding losses.
C. risk-taking regarding losses.
D. always risk-averse.
E. neutral regarding risk.
See Section 8.2

Blooms: Remember
Section: 8.2
8-39
21. Which one of the following statements is correct regarding prospect theory?
A. Average investors tend to lose more money than they earn from investing.
B. Typical investors feel that losing $1 is twice as painful as the pleasure derived from
making $1.
C. Investors should focus on gains and losses in individual securities rather than their
portfolio's total value.
D. Typical investors tend to react irrationally only when focusing on total portfolio value.
E. Average investors tend to prefer higher levels of risk.
See Section 8.2

Blooms: Remember
Section: 8.2
22. Phil is a contestant on a game show. At this point in the game, he can either accept $500
or spin a wheel for a chance of winning $100,000. Which type of behavior is he displaying
if he spins the wheel?
A. forward-looking
B. risk-adverse
C. prospective
D. introspective
E. risk-taking
See Section 8.2

Blooms: Understand
Section: 8.2
Topic: Risk-Adverse Behavior
8-40
23. Investors tend to make better decisions when looking at a decision:
A. based on historical performance.

B. only in respect to potential losses.
C. based on individual securities.
D. in broad terms.
E. based on historical costs.
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Frame Dependence
24. Which one of the following is an example of mental accounting?
A. associating a security's gains or losses based on its purchase price

B. calculating the gain or loss on a security on a daily basis
C. computing the amount of tax due on the gain from a stock sale
D. considering the gain realized when a stock pays a dividend
E. comparing the gains and losses on a portfolio to those of the overall market
See Section 8.2

Blooms: Understand
Section: 8.2
Topic: Mental Accounting
8-41
25. According to the concept of loss aversion, individual investors are most apt to do which
one of the following?
A. sell stocks with gains more frequently than stocks with losses
B. sell stocks with losses more frequently than stocks with gains
C. hold stocks with gains and sell stocks with losses
D. sell all stocks after a pre-determined length of time
E. hold all stocks unless they decline more than ten percent in value
See Section 8.2

Blooms: Understand
Section: 8.2
Topic: Loss Aversion
26. According to the concept of house money, individual investors are most apt to do which
one of the following?
A. take more risks with their initial investment than with the gains on that investment
B. value money differently depending upon its source
C. treat paper profits the same as initial cash investments
D. apply the same level of risk-aversion to all investments
E. place high value on paper profits but low value on paper losses
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: House Money
8-42
27. Peter hesitates when it comes to picking an individual stock to purchase as he feels that
he will later realize that a different stock would have been a better investment. Peter is
suffering from:
A. money illusion.
B. frame dependence.
C. regret aversion.
D. risk-taking.
E. mental accounting.
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Regret Aversion
28. The tendency to overvalue an item because you own it is referred to as which one of the
following?
A. endowment effect
B. money illusion
C. regret aversion
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Endowment Effect
8-43
29. Yesterday, Krista stated that Overland stock was only worth $12 a share and since it was
selling for $15 a share, she declared it overpriced and refused to buy any shares. This
morning, she learned that she is inheriting 3,500 shares of Overland stock from her
grandmother. Suddenly, she is saying that Overland stock is a great buy at $15 and is
probably worth at least $17 a share. This is an example of which one of the following?
A. endowment effect
B. money illusion
C. regret aversion
See Section 8.2

Blooms: Understand
Section: 8.2
Topic: Endowment Effect
30. Ted constantly ignores the effects of inflation on money. Ted is suffering from which one
of the following?
A. endowment effect
B. money illusion
C. regret aversion
See Section 8.2

Blooms: Remember
Section: 8.2
Topic: Money Illusion
8-44
31. Investors who tend to invest too heavily in the securities issued by their employer suffer
from the condition known as:
A. overconfidence.
B. loyalty adherence.
C. status quo.
D. local adhesion.
E. familiarity.
See Section 8.2

Blooms: Remember
Section: 8.3
Topic: Overconfidence
32. Which one of the following statements appears to be correct based on current research?
A. Single, female investors tend to earn lower returns than their male counterparts.
B. Overconfidence tends to result in lower returns.
C. Excessive trading tends to increase returns.
D. Men tend to trade less frequently than women.
E. Investors with higher incomes tend to be more risk-adverse than other investors.
See Section 8.3

Blooms: Remember
Section: 8.3
8-45
33. The increased cash flows into mutual funds that have recently had superior returns is
most associated with which one of the following characteristics?
A. overconfidence
B. excess trading
C. clustering illusion
D. diversification
E. risk aversion
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Clustering Illusion
34. Tricia has lost money on a particular stock for the past three years. Thus, she believes the
stock will have a high positive rate of return this year because earning a good return is
long overdue. This assumption is best described as the:
A. law of small numbers.

B. house money effect.
C. gambler's fallacy.
D. false consensus.
E. recency bias.
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Gambler's Fallacy
8-46
35. Four of the last five stocks your investment adviser recommended have outperformed the
market.
Thus, you believe that if you continue to follow her advice, that 80 percent of your
investments will outperform the market over the long term. This belief is based on the:
A. gambler's fallacy.
B. law of small numbers.
C. law of large numbers.
D. clustering illusion.
E. positive performance illusion.
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Law of Small Numbers
36. According to the theory of recency bias, investors tend to believe the financial markets
will:
A. gravitate to their long-term average rates of return.

B. react over the next year in direct opposition to the performance of the prior year.
C. have a maximum of three years of positive annual returns before declining somewhat.
D. continue to perform as they have over the past couple of years.
E. tend to reverse direction at least every five years.
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Recency Bias
8-47
37. Which one of the following is a characteristic of the self-attribution bias?
A. believing what you wish to believe

B. placing too much weight on information which you can gather easily
C. believing that other investors agree with your thinking
D. taking credit for the wins and blaming the losses on bad luck
E. believing that your recent performance is an indication of your future performance
See Section 8.4

Blooms: Remember
Section: 8.4
Topic: Self-Attribution Bias
38. Which of the following are impediments to the correction of a security's mispricing?
I. sentiment-based risk
II. implementation costs
III. firm-specific risk
IV. noise trader risk
A. II only
B. II and IV only
C. I, III, and IV only
See Section 8.6

Blooms: Remember
Section: 8.6
Topic: Limits to Arbitrage
8-48
39. Which one of the following market sentiment index (MSI) values represents the best
buying opportunity?
A. 0.16
B. 0.29
C. 0.48
D. 0.61
E. 0.82
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Market Sentiment Index
40. Which one of the following market sentiment index (MSI) values indicates that all polled
investors were bearish?
A. -1
B. 0
C. 1
D. 50
E. 100
See Section 8.7

Blooms: Remember
Section: 8.7
8-49
41. Which one of the following indicates the long-run direction of the market according to Dow
Theory?
A. daily fluctuations
B. secondary reaction
C. monthly changes
D. primary trend
E. tertiary trend
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Dow Theory
42. What is the primary purpose of Dow theory?
A. to measure the level of investor optimism and pessimism

B. to analyze daily market movements
C. to identify and measure market waves
D. to eliminate market corrections
E. to signal changes in the market's primary direction
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Dow Theory
8-50
43. According to Dow theory, which one of the following is the primary means of eliminating
secondary market trends?
A. corrections
B. confirmations
C. continuations
D. conversions
E. coordinated trades
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Dow Theory
44. If you are a proponent of the Elliott wave theory, you are most apt to do which one of the
following?
A. sell on wave 2
B. sell on wave 3
C. buy on wave A
D. buy on wave 2
E. buy on wave 5
See Section 8.7

Blooms: Understand
Section: 8.7
Topic: Elliott Wave Theory
8-51
45. According to technical analysis, which one of the following is best seen as a buying
opportunity?
A. a breakout of a resistance level

B. an MSI value of 0.1 or less
C. a downward sloping advance/decline line
D. a flat advance/decline line
E. top of Elliott wave 5
See Section 8.7

Blooms: Understand
Section: 8.7
Topic: Resistance Level
46. You recently heard a news announcer state that the market is approaching its support
level. Which one of the following is the best interpretation of that statement?
A. The market is approaching the lowest level that is reasonably expected.

B. The federal government will step in to help the market retain its value should the
market slip much further.
C. The market is almost at a peak and is expected to start declining in the near future.
D. The market is almost to the point where trading will be suspended temporarily.
E. The market is almost equivalent in value to the international markets so price
stabilization is expected.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Support Level
8-52
47. Which one of the following advance/decline lines is the most bullish signal?
A. relatively flat
B. slightly upward sloping
C. slightly downward sloping
D. steeply upward sloping
E. steeply downward sloping
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Advance/Decline Line
48. Which of the following are bullish indicators?
I. flat advance/decline line

II. breakout of a support level
III. Arms ratio of .38
IV. heavy advancing volume
A. I and II only
B. III and IV only
C. I and III only
D. II and III only
E. I and IV only
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Technical Indicators
8-53
49. If the closing tick of the day is +32, this means that the:
A. DJIA ended the day up 32 basis points.

B. discount rate at the end of the day was 3.20 percent.
C. number of stocks closing on an uptick was 32.
D. number of stocks closing on an uptick exceeded those closing on a downtick by 32.
E. number of stocks closing on an uptick was 32 more than on the prior trading day.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Closing Tick
50. Which one of the following Arms values is the most bearish?
A. .28
B. .45
C. .88
D. 1.03
E. 1.26
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Arms
8-54
51. For the past year, a particular stock has a relative strength value of 1.03 as compared to
the market. This means that the stock:
A. increased in value 3 percent more than the market for the day.
B. has 3 percent more risk than the average security.
C. outperformed the market for the period.
D. had 3 percent higher trading volume on a growth basis as compared to the market.
E. is selling for 103 percent of the market value per share.
See Section 8.7

Blooms: Remember
Section: 8.7
52. A "block trade" is a trade in excess of how many shares?
A. 1,000
B. 5,000
C. 10,000
D. 50,000
E. 100,000
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Block Trade
8-55
53. Which one of the following statements is correct concerning an open-high-low-close bar
chart?
A. The prices indicated by the two horizontal lines are the maximum and minimum daily
prices.
B. The upper trendline indicates the support level.
C. If the overall price movement is downward, the lower trendline is called the channel
line.
D. If the overall price movement is upward, the upper trendline is called the head line.
E. The final price of the day is indicated by a horizontal line to the left side of the vertical
line.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Price Channel
54. According to technical analysts, pricing patterns such as the head and shoulders are
indicators of potential:
A. reversals from the main trend line.

B. upcoming corrections which will return the market to the current main trend line.
C. increasing strength for the main trend line.
D. decreasing market activity.
E. increasing market activity.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Head and Shoulders Pattern
8-56
55. Which one of the following is correct concerning a head and shoulders top pattern?
A. The outside of the right shoulder is a bullish signal.

B. The shoulders are higher than the head.
C. The left shoulder must be higher than the right shoulder, but lower than the head.
D. A piercing of the neckline is a reversal signal.
E. The trendline must be relatively flat throughout the pattern.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Head and Shoulders Pattern
56. Which one of the following statements is correct regarding moving averages?
A. The 50-day moving average reflects the long-term trend of the market.
B. An exponential moving average is a weighted average.
C. Moving averages are used primarily to measure trading volume.
D. Short-term and long-term moving averages always move in the same direction.
E. Moving averages are generally computed using average daily prices.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Exponential Moving Average
8-57
57. Assume the 50-day moving average is currently intersecting the 200-day moving average.
Also assume the 50-day average is downward sloping and the 200-day average is upward
sloping. Which one of the following statements is accurate based on this information?
A. The 50-day moving average is bullish.

B. The short-term forecast is bullish.
C. The long-term trend may be preparing to change.
D. The long-term outlook is bearish.
E. The short-term trend will change to match the long-term trend.
See Section 8.7

Blooms: Understand
Section: 8.7
Topic: Moving Averages
58. Bollinger bands:
A. graphically reflect the differences between two moving averages.

B. graphically depict the relative strength of a security as compared to the market.
C. are a graphical representation of an exponential moving average.
D. depict a 2-standard deviation bound around a moving average.
E. are equal to the 20-day moving average plus or minus one standard deviation.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Bollinger Bands
8-58
59. A stock's price has been relatively constant for an extended period of time. In this
instance, the Bollinger bands are:
A. relatively close to each other.

B. non-existent.
C. vertical.
D. steeply upsloping.
E. steeply downsloping.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Bollinger Bands
60. Investors who use the MACD indicator as a signal for trading are most apt to buy a
security when the MACD:
A. equals zero.
B. is equal to 1.0.
C. rises above the signal line.
D. parallels the signal line.
E. falls below the signal line.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: MACD
8-59
61. Which of the following are considered in the computation of money flows?
I. last trade price

II. current trade price
III. volume of each trade
IV. time of each trade
A. I and IV only
B. II and III only
C. I, II, and III only
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Money Flow
62. Assume a stock's price remains relatively stable while the money flow becomes highly
positive. Which one of the following is most expected given this scenario?
A. price decrease
B. stable price
C. price increase
D. increasing trading volume
E. decreasing trading volume
See Section 8.7

Blooms: Remember
Section: 8.7
8-60
Topic: Money Flow
63. Fibonacci numbers:
A. are all odd numbers of increasing value.

B. result in a golden mean which has an approximate value of 1.618.
C. are the square roots of the products of the two previous numbers in the series.
D. result in a phi which is approximately equal to .382.
E. are a series of numbers which are equal to the product of the two previous numbers.
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Fibonacci Numbers
64. Some technical analysts use Fibonacci numbers to predict:
A. primary trend breakthroughs.

B. market turnarounds.
C. secondary market trend lines.
D. relative performance values.
E. resistance and support levels.
See Section 8.7

Blooms: Remember
Section: 8.7
8-61
65. Which one of the following is seen as a bearish indicator?
A. decreased short selling

B. increased buying by odd-lot traders
C. shorter skirt lengths
D. a Super Bowl win by a National Football League team
E. tight Bollinger bands
See Section 8.7

Blooms: Remember
Section: 8.7
Topic: Technical Indicators
66. A survey of 64 of your fellow classmates determines that 19 of them are bullish on the
market while the remainder is bearish. What is the market sentiment index for this group
of individuals?
A. .28
B. .33
C. .44
D. .58
E. .70
MSI = (64 - 19)/45 = .70

Blooms: Apply
Section: 8.7
8-62
67. A recent survey indicates that 1,731 people are bearish on the market for every 1,000 that
are bullish. What is the value of the market sentiment index based on this information?
A. .36
B. .43
C. .57
D. .63
E. .75
MSI = 1,731/(1,731 + 1,000) = .6338

Blooms: Apply
Section: 8.7
68. Given the following information, what is the value of the advance/decline line on the third
day of this 3-day period?
A. -277
B. -198
C. +202
D. +326
E. +409
Value of A/D line = 1,315 + 1,650 + 1,300 - 1,416 - 1,128 - 1,312 = +409
Blooms: Apply
8-63
Section: 8.7
69. Given the following information, what is the value of the advance/decline line on the
second day of this 3-day period?
A. -889
B. -804
C. -294
D. +147
E. +402
Value of A/D line = 1,211 + 1,360 - 1,806 - 1,654 = -889
Blooms: Apply
Section: 8.7
8-64
A. .82
B. .84
C. .92
D. 1.11
E. 1.22
Arms = (621,433,125/1,310)/(851,325,120/1,512) = .8425
Blooms: Apply
Section: 8.7
Topic: Arms
A. 0.29
B. 0.36
C. 0.42
D. 2.81
E. 3.45
Arms = (2,408,493,040/2,463)/(318,106,250/914) = 2.81
Blooms: Apply
8-65
Section: 8.7
Topic: Arms
72. Last year, Kathy purchased 3 shares of stock A at $50 a share. At the same time, she
purchased 5 shares of stock B at $35 a share. Today, stock A is valued at $65 a share and
stock B is worth $42 a share. What is the relative strength of stock A as compared to stock
B?
A. .84
B. .88
C. .93
D. 1.04
E. 1.14
Relative strength = (3 × $65)/(5 × $42) = .9286

Blooms: Apply
Section: 8.7
8-66
A. $35.28
B. $35.35
C. $35.41
D. $35.57
E. $35.62
3-day moving average as of day 5 = ($35.01 + $35.16 + $35.89)/3 = $35.35
Blooms: Apply
Section: 8.7
Topic: Simple Moving Average
8-67
A. $42.88
B. $43.13
C. $43.22
D. $43.31
E. $44.61
4-day moving average as of day 7 = ($44.61 + $42.83 + $42.65 + $43.13)/4 = $43.305
Blooms: Apply
Section: 8.7
Topic: Simple Moving Average
8-68
A. $50.81
B. $50.84
C. $50.87
D. $50.90
E. $50.94
Blooms: Apply
Level of Difficulty: 2 Medium
Section: 8.7
8-69
A. $39.04
B. $39.07
C. $39.13
D. $39.22
E. $39.28
Blooms: Apply
Section: 8.7
8-70
A. -213,500
B. -103,000
C. 91,200
D. 187,600
E. 257,800
Blooms: Apply
Section: 8.7
Topic: Money Flow
8-71
A. -290,500
B. -85,100
C. 322,200
D. 235,000
E. 421,400
Blooms: Apply
Section: 8.7
Topic: Money Flow
8-72
79. The series of Fibonacci numbers contains the sequential values of 610 and 987. What is
the next number in this series?
A. 1,264
B. 1,364
C. 1,419
D. 1,597
E. 1,633
Next number = 610 + 987 = 1,597

Blooms: Apply
Section: 8.7
80. The price of a stock increased from $32 to $38. Using phi, what are the primary and
secondary support areas for the stock?
A. $35.33; $33.67
B. $33.67; $35.33
C. $35.71; $34.29
D. $38.14; $36.99
E. $36.99; $38.14
Primary support = $38 - [($38 - $32) × .382] = $35.71

Secondary support = $38 - [($38 - $32) × .618] = $34.29

Blooms: Apply
Section: 8.7
8-73
81. Altoona Train stock increased from $18 a share to $25 a share. Based on phi, what are the
primary and secondary support areas for this stock?
A. $21.46; $19.19
B. $21.67; $20.38
C. $21.79; $20.11
D. $22.12; $20.58
E. $22.33; $20.67
Primary support = $25 - [($25 - $18) × .382] = $22.33

Secondary support = $25 - [($25 - $18) × .618] = $20.67

Blooms: Apply
Section: 8.7
Essay Questions
82. Draw a basic Elliott Wave Pattern. Identify each wave and indicate the waves that are
"corrective" and those that are "impulsive".
Answer will vary
Feedback: Students should draw a pattern similar to Figure 8.4 in the textbook. Waves 1-5
are "impulsive" and waves A-C are "corrective".
Blooms: Understand
Section: 8.7
Topic: Elliott Wave Pattern
8-74
83. Explain the basics of prospect theory and provide an example that illustrates this theory.
Answer will vary
Feedback: Prospect theory is the basic idea that investors respond more strongly to a loss
than to a gain. For example, an investor may feel that it takes a gain of $3 to offset the
pain of losing $1.
Blooms: Understand
Section: 8.2
84. Give some examples of how overconfidence affects investor behavior along with the
results that might be expected based on that behavior.
Answer will vary
Feedback: Overconfidence tends to cause investors to trade too frequently, which

increases trading costs. Overconfidence also causes investors to invest too heavily in their
employer's securities as well as securities of firms with which they are familiar. These
actions cause investor's portfolios to be too concentrated in certain securities and lack
sufficient diversification. Regardless of how overconfidence is displayed, it tends to lower
investor returns.
Blooms: Understand
Section: 8.3
8-75

Fundamentals of Investments Valuation and Management 7th Edition Jordan Test Bank

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Fundamentals of Investments Valuation and Management 7th Edition Jordan Test Bank

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Fundamentals of Investments Valuation

and Management 7th Edition Jordan

Behavioral Finance and the Psychology of Investing

Multiple Choice Questions

2. Which one of the following is the basis for prospect theory?

A. Investors react differently to prospective gains and losses.

3. Which one of the following defines frame dependence?

A. Investors react differently to prospective gains and losses.

A. prior day's market value.

5. Loss aversion is defined as:

A. the inability to mentally acknowledge a loss on a security.

6. Representativeness heuristic is best explained as:

10. Which one of the following best describes heuristics?

A. noise trading bounds

13. Which one of the following risks is related to irrational beliefs?

A. eight-week repetitive trading patterns

20. Prospect theory is based on the concept that investors are:

A. always risk takers.

23. Investors tend to make better decisions when looking at a decision:

A. based on historical performance.

A. associating a security's gains or losses based on its purchase price

A. law of small numbers.

A. gravitate to their long-term average rates of return.

37. Which one of the following is a characteristic of the self-attribution bias?

A. believing what you wish to believe

A. to measure the level of investor optimism and pessimism

A. a breakout of a resistance level

A. The market is approaching the lowest level that is reasonably expected.

I. flat advance/decline line

A. DJIA ended the day up 32 basis points.

52. A "block trade" is a trade in excess of how many shares?

A. reversals from the main trend line.

A. The outside of the right shoulder is a bullish signal.

A. The 50-day moving average is bullish.

58. Bollinger bands:

A. graphically reflect the differences between two moving averages.

A. relatively close to each other.

I. last trade price

A. are all odd numbers of increasing value.

64. Some technical analysts use Fibonacci numbers to predict:

A. primary trend breakthroughs.

65. Which one of the following is seen as a bearish indicator?

A. decreased short selling

Multiple Choice Questions

See Section 8.1

Accessibility: Keyboard Navigation

2. Which one of the following is the basis for prospect theory?

A. Investors react differently to prospective gains and losses.

See Section 8.2

Accessibility: Keyboard Navigation

3. Which one of the following defines frame dependence?

A. Investors react differently to prospective gains and losses.

See Section 8.2

Accessibility: Keyboard Navigation

4. Mental accounting is the process of associating a stock with its:

A. prior day's market value.

See Section 8.2

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A. the inability to mentally acknowledge a loss on a security.

See Section 8.2

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6. Representativeness heuristic is best explained as:

See Section 8.4

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