- Four years ago, economist Splinter forecast GDP growth to be strong because the Federal Reserve would keep interest rates low, but instead GDP was marginally positive as the Fed increased rates in order to keep inflation in check. Splinter blamed his inaccurate forecast on the Fed’s decision to focus on inflation rather than growth. Splinter’s response to his forecast error describes an ego defense mechanism best identified as the: a. “If only” defense b. “Ceteris paribus” defense c. “I was almost right” defense 2. In a discussion, portfolio manager Ninja Turtle states that the specific risks to arbitrage can be managed and provide opportunity for profitable trading. As an example he says “noise trader risk is beneficial to arbitrageurs because it provides higher returns,” and “fundamental risk is partially made better by shorting a substitute stock.” Are Ninja Turtle’s two comments regarding arbitrage risk correct? a. Yes b. No. Only the first comment is correct c. No. Only the second comment is correct 3. Han Solo believes providing financial planning advice will provide clients with a “psychological call option.” If the investment choice turns out well, the client can take credit for the good decision. If it turns out badly, then the client can reduce the level of regret by blaming the advisor. The “psychological call option” Han Solo describes is an example of: a. Regret framing b. Cognitive heuristics c. Self-attribution bias 4. The tendency of some individual investors to have a significant portion of funds allocated to stable value funds is indicative of: a. Anchoring b. Money illusion c. Myopic loss aversion 5. Manager Jar Jar Binks notices that many clients with access to defined contributions plans, like 401(k) and 403(b) plans, have made poor choices. They exhibit poor diversification with an excess amount in the employee’s own company stock. In addition, some plan participants with long time horizons have excess amounts in stable value funds rather than equity funds that will likely grow in value and provide an inflation hedge. Jar Jar decides to meet with plan sponsors to educate them about the benefits to plan participants of proper diversification. He also suggests that plan sponsors make available more equity fund choices because such an expansion of choices might result in participants having a higher allocation to equities. 5. The solution Jar Jar proposed to the problem of poor asset allocations choices seeks to exploit: a. Status quo bias b. Myopic loss aversion c. The endorsement effect 6. The Alfalfa fund has the mission statement to ‘exploit chronic market inefficiencies,’ including arbitrage opportunities and other behavioral biases. The firm has set two guidelines to accomplish this: First, in order to provide a wide selection of opportunities, arbitrage positions will be limited to a one year time horizon. And second, as a price target is approached, the position will be reduced, and any upward price target revision requires justification. Are the Alfalfa fund’s guidelines consistent with its mission statement? a. Yes b. No. Only the first guideline is consistent c. No. Only the second guideline is consistent
- A 2. A 3. C 4. C 5. C 6. A
mwvt9: Can you please explain the difference between “if only” and “Cetreis Paribus” ? Thanks for your help.
- ? 2. A 3. C 4. C 5. C 6. C
GetSetGo Wrote: ------------------------------------------------------- > mwvt9: Can you please explain the difference > between “if only” and “Cetreis Paribus” ? > It is confusing. This is how I look at it - If only: Analyst states that IF the fed keeps interest rates low, THEN the stock market will hit 15,000. Let’s say the Fed raises interest rates. The analyst would say IF they would have keep the rates low (like the I said they would) then my forecast would have been right and the market would have hit 15 K. Of course there is no way to verify this becuause it runs counter to what acutally happened in reality. Ceteris-Paribus: I think this one has more to do with outside “shock” to the forecast. In this case the analyst blames the error on something “no one could have seen coming”. This is different from one of the key inputs that he forecasted being wrong like in the if-only. I am not sure I am right here though, so take my definitions with a grain of salt. These are the two hardest to get a hold of IMO.
- Four years ago, economist Splinter forecast GDP growth to be strong because the Federal Reserve would keep interest rates low, but instead GDP was marginally positive as the Fed increased rates in order to keep inflation in check. Splinter blamed his inaccurate forecast on the Fed’s decision to focus on inflation rather than growth. Splinter’s response to his forecast error describes an ego defense mechanism best identified as the: a. “If only” defense b. “Ceteris paribus” defense c. “I was almost right” defense I think i kind of get his one… Fed’s increase of interest rates is cetris paribus, Fed’s decision to focus on inflation rather than growth is “if only”. Twisted convoluted logic…what else can expect from CFAI. So the answer is A.
mwvt9: Thanks for the explanation. 
GetSetGo Wrote: ------------------------------------------------------- > mwvt9: Thanks for the explanation. Sure. Maybe others can critque and expand a bit.
Good questions and explanations. However, my accuracy was only 50% (I am assuming the correct option for 6 is C, as mentioned by GetSetGo). mwvt, thanks for explaining the difference between Ceretis Paribus and If only bias, very helpful.
A C C C C C
- B 2. A 3. C 4. C 5. C 6. Guess: C
1: C 2: B 3: C 4: C 5: C 6: A
any more explanations for Q2 and Q6 … thanks
level3aspirant: 2. In a discussion, portfolio manager Ninja Turtle states that the specific risks to arbitrage can be managed and provide opportunity for profitable trading. As an example he says “noise trader risk is beneficial to arbitrageurs because it provides higher returns,” and “fundamental risk is partially made better by shorting a substitute stock.” Are Ninja Turtle’s two comments regarding arbitrage risk correct? a. Yes b. No. Only the first comment is correct c. No. Only the second comment is correct Equity risk is divided into fundemental risk or systemic risk and specific risk or individual risk or residual risk. Si if we go long and short in the same industry, we balance out the fundemental risks of that industry, but incure specific risks of those stocks. Noise trader risk refers to information causing excess movements then it is supposed to cause. This is helpful for arbitraguers in both negative and positive direction (because this is an acute market inefficiency …they can buy cheap and sell high). Hope this helps.
Level3aspirant: 6. The Alfalfa fund has the mission statement to ‘exploit chronic market inefficiencies,’ including arbitrage opportunities and other behavioral biases. The firm has set two guidelines to accomplish this: First, in order to provide a wide selection of opportunities, arbitrage positions will be limited to a one year time horizon. And second, as a price target is approached, the position will be reduced, and any upward price target revision requires justification. Are the Alfalfa fund’s guidelines consistent with its mission statement? a. Yes b. No. Only the first guideline is consistent c. No. Only the second guideline is consistent Chronic efficiencies are long term in nature an can last multiple years. Acute inefficiencies last only a few days to a few months. So if a fund wants to exploit chronic inefficiencies, its time horizon may have to be longer than one year. The guideline is OK with the one year time horizon. Hope this helps.
thanks a ton. that was really simple to understand.
I go BBCCCC. Not sure about 2nd one though. I can see GetSetGo’s point, but it’s not an arbitrage if you haven’t removed the fundamental risk! That’s just buying “undervalued” securities/shorting “overvalued” ones. There’s no arb in there - it’s just a bog standard strategy. I’d argue that noise risk is good for an arb because it increases the size of the anomaly enabling you to reap greater profits. But maybe I’m taking a non-CFA view on the definition of arbitrage. Mine’s better though 
- A is correct. Splinter’s forecast assumed the fed would keep interest rates low focusing on growth, but instead the Fed raised rates focusing on inflation. This is the “if only” excuse. 2. C is correct. The first comment is incorrect, because noise trader risk is the risk that mispricing may get worse, and that the arbitrager may be forced to liquidate at a loss. The second comment is correct. 3. C is correct. The phenomenon of blaming someone else for the decision is an example of self-attribution bias. 4. C is correct. Myopic loss aversion is behavior associated with investors who focus on short term horizons. They tend to look at one-year returns rather than the longer time horizons appropriate for pension fund investing. 5. C is correct. The endorsement effect refers to the participant inferring the range of fund choices offered as a suggestion (endorsement) of the best way to allocate funds. 6. C is correct. Only the second guideline is consistent with Alpha Fund’s mission. Chronic inefficiencies may exist for a number of years. Rigidly adhering to a one-year time horizon may force the manager to sell at a significant loss. The policy of price-target revision is consistent adhering to a well thought out plan.
Nice job AllLevelsPass.
ABACCC for me: 4/6 = FAIL. Looks like I have some work to do…