JOE DIVIDES HIS ASSETS EQUALLY AMONG ALL AVAILABLE ALTERNATIVES

1/n diversification: Joe divides his assets equally among all available alternatives.

Status quo bias: Joe has made no changes to his portfolio.

Candidate discussion:

Joe may show loss aversion, but that is not the same thing as myopic loss aversion. Myopic loss

aversion is a macro issue when large numbers of investors under-allocate to stocks, keeping

their prices low and biasing upward their return premium. Joe is not showing conservatism

because that is a cognitive error when an initially rational view is formed but then retained without

further consideration as new information comes in. Joe made an initial, uninformed, and not well-

thought-out decision that he does not change. It is conceivable he has some of these other

biases, but we know he exhibited the two selected, so other selections will receive no credit. 1

point each for a correct identification and 1 point for supporting it.

(Study Session 3, LOS 7.c)

B. Based solely on his 401(k) investment portfolio, select the investor behavioral type (BIT) most

likely exhibited by Joe and justify your selection with one reason.

Grading Guide

Answer for Question 1-B

Personality Type

(circle one) Comments

 Joe's primary concern is avoiding losses, suggesting he has low risk

tolerance.

Guardian

or

 Joe is cautious and wants to protect his assets.

Candidate discussion: 2 points for guardian and 1 point for one reason supporting the

classification.

(Study Session 3, LOS 7.a)

After several years, the Finnegans become dissatisfied with managing their own portfolio and

approach Tim Smith in the bank trust department for advice. Smith conducts detailed interviews

with the Finnegans and identifies three sets of goals with varying priority. He uses a client

questionnaire and determines that their biases are mainly emotional. Because of their lack of

investment success, he concludes that meeting their primary goals will be difficult. He then

develops both a goals-based investment plan and one based on traditional financial concepts.

C. Explain both how Smith would structure a goals-based investment plan for the Finnegans and

the advantage of such a plan for them.

Answer for Question 1-C

Structure the plan in three layers, one for each priority level of goals. The highest priority goals

would be funded with lower risk assets, the lowest priority with higher risk assets, and the middle

priority with medium risk assets.

The advantage to the client is to see how high priority goals are less likely to be endangered by

market declines and, thus, help the client stick with the investment plan during stressful market

periods.

Candidate discussion: 1 point for covering the 3 layers and 1 point for the risk characteristics in

each layer. 2 points for conveying that the client is more likely to stay with such a plan and, thus,

come out ahead in the long run.

D. Explain one reason Smith would and one reason Smith would not deviate from the traditional

plan asset allocations. Each reason must be based directly on the information provided regarding

the Finnegans.

D.

 Deviate because their biases are mainly emotional and that will make convincing them to

change difficult.

 Do not deviate because there is high standard of living risk. Their assets are small enough

that meeting primary goals will be difficult. Therefore, they cannot afford to deviate from

traditional finance efficiency.

Candidate discussion: 1 point each for identifying the two relevant pieces of information and 1

point each for why one supports less and one more deviation from traditional efficiency.

ANSWER QUESTIONS 2 AND 3 IN ORDER.

QUESTION 2 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 18 MINUTES

Lachlan Martin and his wife Chloe are both 50 years old, have no children, and live in Sydney,

Australia. Lachlan's father, Liam Martin, recently died and left his entire estate to Lachlan.

Lachlan expects to receive his after-tax inheritance of 9.0 million Australian dollars (AUD) in one

year. The Martins both plan to retire at that time, and are meeting with Zoe White to help them

establish an investment plan.

The Martins currently own a home valued at AUD 3.9 million, do not have a portfolio of investable

assets, and do not consider their home as part of their investable assets. In one year, the

Martins' outstanding debt will be AUD 3.7 million (home mortgage) and AUD 160,000 (other

debts). The Martins will pay off their mortgage and their other debts once the inheritance is

received.

The Martins currently have a combined after-tax salary of AUD 500,000, current-year living

expenses of AUD 263,000, plus annual mortgage payments (principal + interest) of AUD