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
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