Investments, tenth edition

a )–( c 

) identify the behavioral finance concept most directly exhibited. 

Explain how each behavioral finance concept is affecting Maclin’s investment decision making.  

   4.  During an interview with her investment adviser, a retired investor made the following two 

statements:

     a.   “I have been very pleased with the returns I’ve earned on Petrie stock over the past 2 years and 

I am certain that it will be a superior performer in the future.”  

    b.   “I am pleased with the returns from the Petrie stock because I have specific uses for that money. 

For that reason, I certainly want my retirement fund to continue owning the Petrie stock.”   

    Identify which principle of behavioral finance is most consistent with each of the investor’s two 

statements.  

   5.  Claire Pierce comments on her life circumstances and investment outlook:

  I must support my parents who live overseas on Pogo Island. The Pogo Island 

economy has grown rapidly over the past 2 years with minimal inflation, and 

consensus forecasts call for a continuation of these favorable trends for the 

foreseeable future. Economic growth has resulted from the export of a natural 

resource used in an exciting new technology application. 

 I want to invest 10% of my portfolio in Pogo Island government bonds. I plan 

to purchase long-term bonds because my parents are likely to live more than 

10 years. Experts uniformly do not foresee a resurgence of inflation on Pogo 

Island, so I am certain that the total returns produced by the bonds will cover my 

parents’ spending needs for many years to come. There should be no exchange 

rate risk because the bonds are denominated in local currency. I want to buy 

the Pogo Island bonds, but am not willing to distort my portfolio’s long-term 

asset allocation to do so. The overall mix of stocks, bonds, and other investments 

should not change. Therefore, I am considering selling one of my U.S. bond 

funds to raise cash to buy the Pogo Island bonds. One possibility is my High Yield 

Bond Fund, which has declined 5% in value year to date. I am not excited about 

this fund’s prospects; in fact I think it is likely to decline more, but there is a small 

probability that it could recover very quickly. So I have decided instead to sell my 

Core Bond Fund that has appreciated 5% this year. I expect this investment to 

continue to deliver attractive returns, but there is a small chance this year’s gains 

might disappear quickly. 

 Once that shift is accomplished, my investments will be in great shape. The 

sole exception is my Small Company Fund, which has performed poorly. I plan to 

sell this investment as soon as the price increases to my original cost.   

 Identify three behavioral finance concepts illustrated in Pierce’s comments and describe each of the 

three concepts. Discuss how an investor practicing standard or traditional finance would challenge 

each of the three concepts.    

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  C H A P T E R  

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  Behavioral Finance and Technical Analysis  

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    1.  Conservatism implies that investors will at first respond too slowly to new information, leading to 

trends in prices. Representativeness can lead them to extrapolate trends too far into the future and 

overshoot intrinsic value. Eventually, when the pricing error is corrected, we observe a reversal.  

   2.  Out-of-favor stocks will exhibit low prices relative to various proxies for intrinsic value such as 

earnings. Because of regret avoidance, these stocks will need to offer a more attractive rate of 

return to induce investors to hold them. Thus, low P/E stocks might on average offer higher rates 

of return.  

   3.  At liquidation, price will equal NAV. This puts a limit on fundamental risk. Investors need only 

carry the position for a few months to profit from the elimination of the discount. Moreover, as 

the liquidation date approaches, the discount should dissipate. This greatly limits the risk that 

the discount can move against the investor. At the announcement of impending liquidation, the 

discount should immediately disappear, or at least shrink considerably.  

   4.  By the time the news of the recession affects bond yields, it also ought to affect stock prices. The 

market should fall  before  the confidence index signals that the time is ripe to sell.       

  E-INVESTMENTS EXERCISES 

    1.  Log on to   finance.yahoo.com   to find the monthly dividend-adjusted closing prices 

for the most recent 4 years for Abercrombie & Fitch (ANF). Also collect the closing level 

of the S&P 500 Index over the same period.

    

a.  Calculate the 4-month moving average of both the stock and the S&P 500 over 

time. For each series, use Excel to plot the moving average against the actual level 

of the stock price or index. Examine the instances where the moving average and 

price series cross. Is the stock more or less likely to increase when the price crosses 

through the moving average? Does it matter whether the price crosses the mov-

ing average from above or below? How reliable would an investment rule based 

on moving averages be? Perform your analysis for both the stock price and the 

S&P 500.  

   

b.  Calculate and plot the relative strength of the stock compared to the S&P 500 

over the sample period. Find all instances in which relative strength of the stock 

increases by more than 10 percentage points (e.g., an increase in the relative 

strength index from .93 to 1.03) and all those instances in which relative strength 

of the stock decreases by more than 10 percentage points. Is the stock more or 

less likely to outperform the S&P in the following 2 months when relative strength 

has increased or to underperform when relative strength has decreased? In other 

words, does relative strength continue? How reliable would an investment rule 

based on relative strength be?     

   2.  The Yahoo! Finance charting function allows you to specify comparisons between 

 companies by choosing the  Technical Analysis  tab. Short interest ratios are found in the 

 Key Statistics  table. Prepare charts of moving averages and obtain short interest ratios 

for GE and SWY. Prepare a 1-year chart of the 50- and 200-day average price of GE, 

SWY, and the S&P 500 Index.

    

a.  Which, if either, of the companies is priced above its 50- and 200-day averages?  

   

b.  Would you consider their charts as bullish or bearish? Why?  

   

c.  What are the short interest ratios for the two companies?