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FINA/MANA 7397 Behavioral Finance Exam 2 will be on Friday, June 29 from 5-8 p.m. Exam Tips: For exam, know the learning objectives forwards/backwards/inside/out. Be able to apply concepts and theories to new situations. When preparing, make up new problems and apply the course concepts. Study with other members of the class. Put forth a strong effort as you prepare for the final exam. Coverage of exam: Notes: pp. 50-73. Nofsinger chapters 5,6,7 (see related learning objectives below) Relevant problems: p. 58-60, #1-7; pp. 66-68, # 1-7; p. 71, # 1-4; p. 73, #1 Learning Objectives for Exam 2 1. Be able to describe and apply prospect theory. Be able to draw a prospect theory diagram for a situation that I give you. 2. Be able to describe and apply the perception model (attention, organization, figure & background, closure), operant theory (Thorndike's law, positive reinforcement, punishment, stimulus control, habituation, positive feedback trading, S-B-C model), and heuristics (availability, representativeness, and anchoring & adjustment).. 3. Given a situation and a list of biases (including the prospect theory biases) and/or heuristics, be able to select the bias or heuristic that is most applicable to the situation. These will be multiple choice questions. 4. If I give you a heuristic or bias and ask you to apply it to a situation, be able to do so. For example, I might ask you to indicate how a stockbroker who is selling to a new client might use the hindsight bias. You could state that the broker should ask to see a list of the new client's investments. The broker should show the new client alternative investments that had performed better than the new client's and state, "Had you been my client, these are what your investments and returns would have been." Underlying message, under my guidance you will earn higher returns. This is an application of the hindsight bias because it is easy to look back and find higher performing investments. 5. Expertise. What is it? What are the five steps in development of expertise? What are the implications for developing investment expertise? 6. Winners curse. What is it? What are the leverage points for it? 7. Commitment theory-- nonrational escalation of commitment (five conditions for commitment, factors that further enhance commitment, remedies. 8. What is the nature of the stock market as an environment in which we make decisions? How do the psychological processes of the average investor get him/her into trouble in this environment? 9. Be able to describe and apply paradigms, anomalies, normal science, and scientific revolutions and to summarize their roles in scientific progress. 10. Be able to compare and contrast rationalist and behavioralist paradigms using relevant criteria (e.g., preferred language, level of analysis, etc.). 11. Be able to classify a research study on the continuum between the rationalist and behavioralist paradigms using the criteria of a) level of analysis, b) dollar incentive, and c) decision maker experience. Be able to identify the causal model that is being tested by the research. 12. In class we discussed studies of the literacy level of U.S. citizens and the investing expertise of mutual fund investors which raise serious questions about the "rationality" of investors. What implications do these studies have for the question of investor rationality? How might a rationalist explain away these implications? 13. What is the course rationale for investing in index funds? Using course concepts, explain why so few investors do so. That is, why do many investors believe that they can beat the market? 14. What are the three forms of business ownership? What are tax and legal liability implications of each? What is a mutual fund? What are actively managed and passively managed index funds? What are index funds? Why does the EMH support the use of index funds? What are advantages and disadvantages of index funds? 15. Given all that we have studied this semester, what is the future for the field of behavioral finance? What are some key issues for the field? Additional learning objectives for exam 2 include the following: 1. From Nofsinger text book a) Mental accounting (chapter 5) b) Naïve diversification (chapter 6) c) The “1/n rule” (chapter 6) d) Familiarity bias (chapter 7)