BAFNIU18223_BA217IU_Nguyen Le Hoang Long _Spring2021

SECTION A – SHORT ANSWER (50 MARKS)

Question 1: Susan purchases a new luxury vehicle every two years and takes expensive annual
vacations. She has a reputation for paying the entire bill at the upscale restaurants where she
dines regularly with her friends. Susan’s annual consumption, options trading, and housing
expenditures are paid for entirely out of her salary income and half of her modest annual bonus.
She deposits the other half of her annual bonus and any other non-salary sources of income into
her relatively small retirement account, which excludes her options trading. Susan is reluctant to
incur debt and has only a small mortgage on her home, despite the fact that she will soon be
made a partner in her firm and will have much higher earnings. Murray believes that Susan
exhibits behavioral biases that interfere with an optimal savings and consumption allocation. In
particular, he thinks that she is not saving enough for retirement.
A. Discuss how Susan’s behavior reflects the bias of mental accounting. [15]
B. Explain how a rational economic individual in traditional finance would behave
differently with respect to the bias. [15]

Answer:
a. Susan is a person with strong beliefs, and she appears to have given little attention
to her money. The majority of her money is spent on speculating rather than
savings. Even if additional money arrives from such speculation, her consumption
is so great that she will ultimately devour it all.

b. Her beahavior is totally different from savings perspective. she is debt-free and
does not want to be burdened; she likes her life and independence. She can only
afford such high-risk investments because of her personality characteristics.
Murray has seen that Siosan is not saving enough for her retirement. Today's
investment yields are historically low, thus retiring requires a large sum of money.
Aside from being a high-earning member of society, she is subject to economic
financial cycles. Cycles such as the present recession or stock market volatility
may wipe away her retirement money in an instant. Money market securities are
hazardous, and speculative stocks are much worse. So, when it comes to
retirement savings, you really must not invest in riskier choices.

Question 2: Angus has always held shares of a big oil company’s stock and has never thought
about branching out to other companies or industries in the energy sector. His investment has
done well in the past, proving to him that he is making the right decision. Angus has been
reading about fundamental changes predicted for the energy sector, but he decides to stick with
what he knows.
a. In what ways is Angus’s investment behavior irrational? [10]
b. What kinds of investor biases does his decision-making reveal? [10]

Answer:
a. Angus believes he is thinking rationally about knowing what he knows, which
leads him to his irrational decision due to the reality of misunderstanding context.
His prejudice causes him to accentuate or even ignore information that drives him
BAFNIU18223_BA217IU_Nguyen Le Hoang Long _Spring2021

to a want to stay with the oil firm. As a result, he is unable to see another
opportunity.

b. His behavior causes him to make unexpected and biased conclusions'. This point
of view prevents him from thinking objectively. Angus has an overconfidence
bias, which means he places too much reliance in his estimates.

SECTION B – CASE STDUY (50 MARKS)

QUESTION: What are the potential reasons for the price fluctuation of Bitcoin in the financial
market? Apply behavioral finance theories to support your answers (where applicable).

Answer:
The bubble behavior of Bitcoin is fed by macroeconomic variables, implying that market
inefficiency will increase; thus, there is a notion of experience of “fad” in the Bitcoin market,
and this will produce a combination of different market news and events that will cause a strong
effect on Bitcoin price volatility. Increased volatility as a result of increased trading is also
explained by bubble-like behavior. Unsophisticated Bitcoin noise traders are readily influenced
by the expectations and conduct of others; this can lead to “herding behavior,” in which choices
are primarily made based on heuristics rather than real evaluations.

According to conventional finance theory, investor behavior has little effect on asset values. The
rationale for this is defined by the investors' demand, which will be offset by the arbitrageurs'
transactions and trades. Investors think that they make reasonable and sensible investing
decisions. However, as per behavior finance theory, investor conduct has a substantial impact on
asset values. This suggests that behavioral finance variables have a substantial role in influencing
investment decisions made by bitcoin market participants. The bitcoin market's bubble is created
by noisy traders, who make the market inefficient. As a result, market makers give a hypothesis
to behavior finance variables such as swarming, prospect, and heuristic theories, which are
significant variables in understanding the bitcoin market.

Investors' selections about the sorts of digital currencies are influenced by the choices of other
investors, which has a substantial impact on their investment decisions. Furthermore, when
investors benefit from their investment, they will make another investment decision in picking
their next portfolios based on their experience, knowledge, and abilities, implying that investors
act as speculators in the bitcoin market.