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Page 58 Level III

QUESTION 10 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 16 MINUTES.

Claudia Corbett, 50 years old, recently reallocated her portfolio. The portfolio was previously

allocated 90% to equity mutual funds and 10% to bond mutual funds. After reading that her

percentage allocation to fixed income should equal her age, she changed to a 50% equity and

50% fixed-income allocation.

Corbett’s portfolio has always been invested entirely in Van Gogh mutual funds, a well-known

family of funds with below-average fees covering a large number of market segments. She

briefly considered switching to other investment companies, but decided to continue to use Van

Gogh’s mutual funds because they met her basic requirements of convenience, good reputation,

and fund variety.

A. Explain why each of the following is consistent with bounded rationality:

i. Corbett’s new asset allocation

ii. Corbett’s choice of mutual fund company

6 minutes (Answer 10-A on page 59)

Corbett hires Jeremy Jung, a fee-only financial advisor, to review her investment portfolio. Jung

administers a risk tolerance questionnaire to Corbett and discusses her financial goals and

constraints. Based on the interview, he concludes that one behavioral bias exhibited by Corbett

is availability.

Jung uses a proprietary model to generate a proposed diversified portfolio of mutual funds that

has the highest expected Sharpe ratio. His analysis suggests that Corbett switch from Van Gogh

Funds to mutual funds sponsored by Infinity Funds, a highly regarded but less well-known

investment company than Van Gogh.

B. Determine, assuming Jung’s bias conclusion is correct, whether Corbett would most

likely remain with Van Gogh or switch to Infinity. Justify your response with two

reasons.

5 minutes (Answer 10-B on page 60)

After further assessment, Jung concludes that Corbett’s dominant behavioral biases are loss

aversion bias and overconfidence bias. In addition, he determines she has a low probability of

outliving her assets due to her significant wealth and modest lifestyle.

C. Recommend, assuming Jung’s bias conclusion is correct, whether he should moderate or

adapt to Corbett’s behavioral biases. Justify your recommendation with two reasons.

5 minutes (Answer 10-C on page 61)

Answer Question 10-A on This Page