Cfa Level 3 2013 Summary

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Behavioral Heuristics – Check Anchor/OAR Availability– Conservatism, Anchoring, Overconfidence, Ambiguity aversion, Representativeness, Availability Traditional Finance – TF-RAR - Risk averse, Asset integration, Rational expectations Behavioral Finance – BF-LAB - Loss averse, Asset segregation, Biased expectations Type of Investors – CMIS - Cautious, Methodical, Individualistic, Spontaneous IPS Process – OCSAEEA, Old Cars Sell At Eastern European Auctions – Objectives, Constraints, Strategy, Allocation, Execution, Evaluation, Adjustments IPS Constraints – URLIT - Unique, Regulatory/legal, Liquidity, tIme, Tax TDA vs. TEA – Higher Enders Take TEA – Higher Ending Tax rate TEA better Residence vs. Source – Pay Greater rate with Credit, Exempt Source Income, Deduct Paid Taxes If our Human Capital is Bond-like, we should invest more aggressively (equity) and our demand for life insurance increases. -------------------------------------------------

Type I & II Error – Type I, I did something (rejected H0) wrong; Type II, failed TO reject H0 -------------------------------------------------
Null = Manager adds no value; Reject & conclude that manager adds value when he actually does not. DB Risk Toler/Objs. Factors– P.S. San Francisco Risked Everything With Certain Plan Features - Pension Surplus, Sponsor Finances, Risk Exposures, Workforce Characteristics, Same Prudent Man Rule : Foundation for all write stds. Of prudence apply in Legal/Reg. Prudent Expert : DB/DC plan

Prudent Investor : Endowment, Life Insurance
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Prudent Man Rule: the requirement that a trustee, investment manager of pension funds, treasurer of a city or county, or any fiduciary (a trusted agent) must only invest funds entrusted to him/her as would a person of prudence, i.e. with discretion, care and intelligence. Prudent Man Rule requires that each investment be judged on its own merits. Under the Prudent Man Rule, speculative or risky investments must be avoided. investments aren't viewed in a portfolio context.

Prudent Expert Rule: Revised version of the prudent man rule required by ERISA to guide managers of pension and profit sharing portfolios. The main addition is that the manager must act as someone with familiarity with matters relating to the management of money, not just prudence.

Prudent Investor rule: This is a modified version of Prudent Man Rule in that it views asset allocation from a portfolio context. An asset (like derivatives) may be too risky to invest if considered on a stand-alone basis but can provide diversification benefits if viewed in a portfolio context. Life insurance companies' RETURN objective : APEG

(Actuarial + Positive interest rate spread + Enhance Margin + Growth Surplus) -------------------------------------------------
An investor whose decisions are impacted by mental accounting will look at investments as separate, focusing on the risk of investments in isolation.

According to behavioral finance, expert forecasters are overconfident in their forecasting ability due to cognitive dissonance.

Cognitive dissonance states that individuals will avoid information (reflecting what has been actually experienced) that is in disagreement (dissonance) with the individual’s perceived ability of himself or herself. As a result, experts will have limited recollection of their failures.

Frame dependence refers to investors' tendency to frame their tolerance on the current direction of the market or in the context of the information received rather than on its own merits.

Anchoring refers to the inability to fully incorporate (adjust) the impact of new information on projections.

Representativeness can cause investors’ perceptions to be based upon current or historical information rather than unbiased expectations resulting in overpriced “winners” underperforming and underpriced “losers” outperforming as prices return to...
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