Msc Finance: Behavioural Finance Problem Set 1

Behavioural Finance and the Psychology of Investment - Assessment 2013-2014

Contact details

Arief Daynes: tel. 02392 844182, extn. 4182, email

David Latimer: tel. 02392 844013, extn. 4013, email

Paraskevas Pagas: tel. 02392 844721, extn. 4721, email

Assignment

The assignment is a written, individual assignment worth 40% of the total grade for the unit. You are asked to write a 2,000 word essay on the following.

The requirements of the assignment are important. Please read the following carefully.

The UK insurance industry currently has the following life-expectancy forecasts for people in their early 20s: Men, 82 years; Women, 84 years; at least one partner of a couple, 86 years. Thus, most people on the Behavioural Finance unit have lifetime investment horizons of over 60 years. This is what we mean by the very long term.

For the very long term investor there is something special about the stock market. There are strong arguments and evidence that say that the stock market is the best asset class for the very long term investor. This means that for your very long term future you should be investing in the stock market. So even if your future career has nothing to do with the stock market, you still have to know how the stock market works.

Assignment requirement: Write a 2,000 word essay. In the course of your essay you must answer the following questions (not necessarily in the same order in which they are given):

(1) Explain why the stock market is regarded as the best asset class for the very long term investor.

(2) What is the difference between passive investing and active investing?

(3) If you believe in modern finance and the EMH you will be a passive investor. If you believe that behavioural finance can be applied to very long term stock market investing you will be an active investor. Explain why?

(4) Are you going to be an active or a passive investor? Why?

(5) What does beating the market mean?

(6) Being an active investor is the same thing as trying to beat the market. Explain.

(7) The only justification for being an active rather than a passive investor is that you have good grounds for believing that you can systematically apply the ideas of behavioural finance to consistently beat the market over a time horizon of 60+ years. Explain why the preceding sentence is true.

Suppose your answer to (4) is that you are going to be an active investor. Then answer the following questions.

(4(a1)) Explain clearly what very long term active strategies you are going to apply.

(4(a2)) Explain why they will work and make sure to explain why they will still be working in 20, 30, 40, 50 or 60 years from now.

(4(a3)) Explain what is wrong with the modern finance and EMH arguments and evidence that there is no thing as a very long term strategy for beating the market.

Suppose your answer to (4) is that you are going to be a passive investor. Then answer the following questions.

(4(p1)) What is so convincing about the arguments and evidence from modern finance and the EMH that there is no way of consistently beating the market over the very long term?

(4(p2)) What is wrong with the arguments and evidence from behavioural finance that there might be active strategies that consistently beat the market over the very long term?

Suppose you do not accept the arguments and evidence that the stock market is the best asset class for the very long term investor then spend the whole of your essay answering the following questions.

(1(n1)) What is wrong with the arguments and evidence that the stock market is the best asset class for the very long term investor?

(1(n2)) So how are you going to invest for your very long term future? Back up your answer with arguments and evidence.

Feedback

At the start of the unit many of you will not even understand what the assignment is asking you to do. We will be discussing the assignment frequently during the lectures and seminars. As you will find out, the assignment is focussed on what is perhaps the most important and practical question in the whole of finance, namely, can you find a way of investing in the stock market that will make you rich?

You probably cannot begin writing drafts of the assignment before Christmas. But you should be thinking about it right from start of the unit.

We cannot give detailed feedback on drafts of your essays. However, we can advise you whether or not you are going about answering the essay in the right way.

If you are not sure if you are approaching the essay in the way that we require then you must come and see one of the unit lecturers to get advice.

This is important. Your lecturer might tell you something like ‘This is a good essay but on a different question from what the assignment is asking’.

Word limit

The maximum number of words for the essay is 2,000 words, not including your bibliography.

If you exceed the word limit the examiners will mark only the first 2,000 words. The essay should not be less than 1,800 words.

Presentation

The first page should be the cover sheet containing information such as the course, unit, and your student ID. Do not put your name on the assignment (this is a university regulation).

The essay itself should start on page 2. At the top of page 2 you must put the word count. The word count must be less than or equal to 2,000 words.

The final pages should be a bibliography of the works you have referred to in the essay. The 2,000-word limit does not include the bibliography.

Staple it all together with one staple only in the top left hand corner.

The essay should be written on A4 and word-processed. You can print on just one or both sides of the page, and it can be single or double-spaced.

You may find it useful to use some tables or graphs in the essay. However, only include tables or graphs if they improve the content of your essay.

This is a finance assignment, not an IT or desktop publishing assignment. There are no marks whatsoever for unnecessary graphics, pictures or other presentational devices that look nice but don’t say anything.

Finally, NO PLASTIC COVERS.

So, the presentation should be minimal. We are interested in reading about your ideas, the arguments and evidence you present in support of your claims, and the logical structure and clarity of the presentation.

Grammar

There will be no penalty for incorrect grammar provided the examiner can understand meaning of what you say. This is very important. You must state your ideas in your own words.

Hand in date

On or before Friday 28 March 2014. This is the last Friday before the Easter Break. It is your responsibility to know the time at which the office will be closing on this date, which may be earlier than the normal closing time.