AAMS Review Study Set – Complete With Detailed
Solutions
Explains why many investors will not sell anything at a loss. Doing so not only
admits a mistake, but also ends any hope of at least GETTING BACK TO EVEN
Correct Ans - Loss Aversion
Involves the pain of feeling responsible for a loss Correct Ans - Fear of
Regret
The illusion of control that can lead to biased judgements and failure to realize
that they are at an informational disadvantage to institutional investors. Can
also mask errors that investors make. Correct Ans - Overconfidence
Involves making judgements based on stereotypes. "This did poorly for me in
the past, so I will never invest in it again". Correct Ans -
Representativeness
How an investor views a situation can have a significant impact on their
decision (investors will often choose a guaranteed positive gain, as opposed to
taking the chance of a greater gain or no gain at all), but they will take a
chance to avoid a negative outcome, rather than taking a certain smaller loss.
Correct Ans - Framing the Problem
Investors that search and rely on information that supports their decisions
and ignores/dismisses info that does not support their decisions. Correct
Ans - Rationalization/Illusion of Validity
Tendency of an investor to look back into the past and see events as having
been more predictable than they seemed before they happened. A
reconciliation of a person's beliefs based on the outcome of events.
Correct Ans - Hindsight bias
Tendency to hold to certain beliefs even when faced with new information
that should alter those beliefs (tunnel vision) Correct Ans - Anchoring
Putting too much weight on current events and not enough weight on past,
historic trends Correct Ans - Recency
,Treating one dollar different from another depending on where it comes from.
E.g. More readily willing to spend money that you won while gambling
because it is the "house money" and not what you originally spent. Correct
Ans - Mental accounting
the misunderstanding people have in relating nominal rates or prices with
real (inflation-adjusted) rates or prices Correct Ans - Money Illusion
the preference to keep things the way they are rather than change Correct
Ans - Status Quo Bias
A person who puts a higher value on something owned rather than on how
much they would be willing to pay for it. E.g. (Selling your house at a price
well above market demand because you have sentimental value towards it).
Correct Ans - Endowment Bias
The potential that, because of inflation, a certain amount of money will not be
able to purchase as much in the future as it does today. Correct Ans -
Purchasing Power Risk (Inflation Risk)
The risk that market interest rates have decreased at the time payments for
an investment are received. An investor forced to reinvest the payment
amount at a time when rates are not as favorable as they may have previously
been. Correct Ans - Reinvestment Risk
the possible reduction in returns associated with changes in interest rates
Correct Ans - Interest Rate Risk
Stems from factors independent of any individual security. These factors
include political events, broad economic and social changes and the mood of
the investing public. Correct Ans - Market Risk
This risk occurs as the value of foreign currencies fluctuate against the U.S.
dollar. Correct Ans - Exchange Rate Risk (Currency Risk)
The possibility of loss (failure) or gain (success) inherent in conducting
business. Associated with the unique nature of the firm's operations,
management and position in the industry. Correct Ans - Business Risk
,The degree to which a company utilizes debt to fund its operations.
Correct Ans - Financial Risk
Refers to the risk that a borrower will default on their debt obligations. The
degree is reflected in the company's or municipality's credit rating
Correct Ans - Default Risk
Refers to the risk that a borrower will not be able to meet their payment
obligations Correct Ans - Credit Risk
The ability to transform the investment into cash in a short period of time
with little or no change in price. There must be a buyer for every seller and a
seller for every buyer Correct Ans - Liquidity Risk
the risk that some major, unexpected circumstance will occur that leads to a
sudden and substantial change in the value of an investment Correct Ans -
Event Risk
Risk that a debt security will be called in by its issuer prior to the maturity
date. Correct Ans - Call Risk
Risk associated with political changes that may negatively impact domestic
and foreign firms. Correct Ans - Political Risk
The risk associated with a less stable economic or social structure of a country
Correct Ans - Country Risk
"The bumpiness of the ride" or the variability of an investment's returns
around its average, or mean, return. Correct Ans - Standard Deviation
This is a measure of a stock's systematic risk and volatility, relative to an
appropriate benchmark. Can be used to indicate the expected movement of a
stock or portfolio relative to the market. Correct Ans - Beta Coefficient
Calculated by multiplying a stock's beta by the percentage that the stock
represents in the dollar value of the portfolio Correct Ans - Weighted
Beta
, A mutual fund that mirrors the market or has an overall beta of 1.0
Correct Ans - Index Fund
The coefficient of determination or the percentage of one's asset's movement
that can be explained by the movement of a second asset. Generally the
"second asset" is an index or a benchmark and the first asset is an individual
stock or mutual fund. If not above 0.7, then "beta" is not a reliable metric
Correct Ans - R-Squared
The formula used to plot the expected return for various levels of risk (beta)
along the security market line Correct Ans - Capital Asset Pricing Model
which is Investment Return = Rf + (Rm-Rf)*Beta Coefficient
The possibility of maintaining an expected level of return at a lower overall
risk level. The further the correlation coefficient is from 1, the greater this
effect Correct Ans - The Diversification Effect
a long-term technique used by investors who purchase an equal dollar
amount of the same stock at equal intervals Correct Ans - Dollar Cost
Averaging
A person invests regularly and periodically an amount that will increase the
account value by a set amount, such as an increase of $100 a month.
Correct Ans - Value averaging
For this course, the general rule of thumb is that 10‒15 large-cap U.S. stocks
(in different industries) are sufficient to eliminate most unsystematic risk,
while small-cap stock portfolios require 20‒30 different issues to achieve the
same level of diversification. This describes what? Correct Ans -
Diversification within asset classes
For example, if the correlation of small-cap stocks is .72 with large-cap stocks
and the correlation of corporate bonds with large-cap stocks is .31, clearly
corporate bonds provide more diversification to large-cap stocks than do
small-cap stocks. This describes what? Correct Ans - Diversification
across asset classes
In general, the risk of investing in volatile assets like stocks decreases as one's
time horizon increases Correct Ans - Time diversification
Solutions
Explains why many investors will not sell anything at a loss. Doing so not only
admits a mistake, but also ends any hope of at least GETTING BACK TO EVEN
Correct Ans - Loss Aversion
Involves the pain of feeling responsible for a loss Correct Ans - Fear of
Regret
The illusion of control that can lead to biased judgements and failure to realize
that they are at an informational disadvantage to institutional investors. Can
also mask errors that investors make. Correct Ans - Overconfidence
Involves making judgements based on stereotypes. "This did poorly for me in
the past, so I will never invest in it again". Correct Ans -
Representativeness
How an investor views a situation can have a significant impact on their
decision (investors will often choose a guaranteed positive gain, as opposed to
taking the chance of a greater gain or no gain at all), but they will take a
chance to avoid a negative outcome, rather than taking a certain smaller loss.
Correct Ans - Framing the Problem
Investors that search and rely on information that supports their decisions
and ignores/dismisses info that does not support their decisions. Correct
Ans - Rationalization/Illusion of Validity
Tendency of an investor to look back into the past and see events as having
been more predictable than they seemed before they happened. A
reconciliation of a person's beliefs based on the outcome of events.
Correct Ans - Hindsight bias
Tendency to hold to certain beliefs even when faced with new information
that should alter those beliefs (tunnel vision) Correct Ans - Anchoring
Putting too much weight on current events and not enough weight on past,
historic trends Correct Ans - Recency
,Treating one dollar different from another depending on where it comes from.
E.g. More readily willing to spend money that you won while gambling
because it is the "house money" and not what you originally spent. Correct
Ans - Mental accounting
the misunderstanding people have in relating nominal rates or prices with
real (inflation-adjusted) rates or prices Correct Ans - Money Illusion
the preference to keep things the way they are rather than change Correct
Ans - Status Quo Bias
A person who puts a higher value on something owned rather than on how
much they would be willing to pay for it. E.g. (Selling your house at a price
well above market demand because you have sentimental value towards it).
Correct Ans - Endowment Bias
The potential that, because of inflation, a certain amount of money will not be
able to purchase as much in the future as it does today. Correct Ans -
Purchasing Power Risk (Inflation Risk)
The risk that market interest rates have decreased at the time payments for
an investment are received. An investor forced to reinvest the payment
amount at a time when rates are not as favorable as they may have previously
been. Correct Ans - Reinvestment Risk
the possible reduction in returns associated with changes in interest rates
Correct Ans - Interest Rate Risk
Stems from factors independent of any individual security. These factors
include political events, broad economic and social changes and the mood of
the investing public. Correct Ans - Market Risk
This risk occurs as the value of foreign currencies fluctuate against the U.S.
dollar. Correct Ans - Exchange Rate Risk (Currency Risk)
The possibility of loss (failure) or gain (success) inherent in conducting
business. Associated with the unique nature of the firm's operations,
management and position in the industry. Correct Ans - Business Risk
,The degree to which a company utilizes debt to fund its operations.
Correct Ans - Financial Risk
Refers to the risk that a borrower will default on their debt obligations. The
degree is reflected in the company's or municipality's credit rating
Correct Ans - Default Risk
Refers to the risk that a borrower will not be able to meet their payment
obligations Correct Ans - Credit Risk
The ability to transform the investment into cash in a short period of time
with little or no change in price. There must be a buyer for every seller and a
seller for every buyer Correct Ans - Liquidity Risk
the risk that some major, unexpected circumstance will occur that leads to a
sudden and substantial change in the value of an investment Correct Ans -
Event Risk
Risk that a debt security will be called in by its issuer prior to the maturity
date. Correct Ans - Call Risk
Risk associated with political changes that may negatively impact domestic
and foreign firms. Correct Ans - Political Risk
The risk associated with a less stable economic or social structure of a country
Correct Ans - Country Risk
"The bumpiness of the ride" or the variability of an investment's returns
around its average, or mean, return. Correct Ans - Standard Deviation
This is a measure of a stock's systematic risk and volatility, relative to an
appropriate benchmark. Can be used to indicate the expected movement of a
stock or portfolio relative to the market. Correct Ans - Beta Coefficient
Calculated by multiplying a stock's beta by the percentage that the stock
represents in the dollar value of the portfolio Correct Ans - Weighted
Beta
, A mutual fund that mirrors the market or has an overall beta of 1.0
Correct Ans - Index Fund
The coefficient of determination or the percentage of one's asset's movement
that can be explained by the movement of a second asset. Generally the
"second asset" is an index or a benchmark and the first asset is an individual
stock or mutual fund. If not above 0.7, then "beta" is not a reliable metric
Correct Ans - R-Squared
The formula used to plot the expected return for various levels of risk (beta)
along the security market line Correct Ans - Capital Asset Pricing Model
which is Investment Return = Rf + (Rm-Rf)*Beta Coefficient
The possibility of maintaining an expected level of return at a lower overall
risk level. The further the correlation coefficient is from 1, the greater this
effect Correct Ans - The Diversification Effect
a long-term technique used by investors who purchase an equal dollar
amount of the same stock at equal intervals Correct Ans - Dollar Cost
Averaging
A person invests regularly and periodically an amount that will increase the
account value by a set amount, such as an increase of $100 a month.
Correct Ans - Value averaging
For this course, the general rule of thumb is that 10‒15 large-cap U.S. stocks
(in different industries) are sufficient to eliminate most unsystematic risk,
while small-cap stock portfolios require 20‒30 different issues to achieve the
same level of diversification. This describes what? Correct Ans -
Diversification within asset classes
For example, if the correlation of small-cap stocks is .72 with large-cap stocks
and the correlation of corporate bonds with large-cap stocks is .31, clearly
corporate bonds provide more diversification to large-cap stocks than do
small-cap stocks. This describes what? Correct Ans - Diversification
across asset classes
In general, the risk of investing in volatile assets like stocks decreases as one's
time horizon increases Correct Ans - Time diversification
