Question

16. Risk and return - Implications for managers and investors The concept of risk and return is subjective for different people, as well as for corporations. Read and assess the following financial decisions. Keeping everything else constant, are the following actions good financial decisions? Base your decisions on the understanding of risk and return, solely from a theoretical finance perspective. Juan is a small business owner. He has some cash flow and wants to invest in a new project. Juan's assistant provides an evaluation and estimates the nominal returns that Juan would earn if he invests in the project. Juan reads the evaluation and makes the decision based on the real terms after factoring in inflation. Good Financial Decision? Yes No The technology boom in the late 1990s enticed everyone. Wilson is an average investor, and he invested all his money in technology stocks. Good Financial Decision? Yes No Erin wants to invest in a hedge fund that has a very strong performance track record. The hedge fund has given its investors a return of over 60% for the past five years. Although Erin is tempted to put her money in the fund, she decides to conduct due diligence on the hedge fund's assets, because she is aware that past performance is no guarantee of future results. Good Financial Decision? Yes No

Answer 1

16. 1) YES, Juan made a good financial decision as he considered his returns in real terms which will let him take into consideration the purchasing power.

2) NO, Wilson did not make a good decision as diversification is necessary to reduce risk, he has decided to make his portfolio exposed to concentrated risk which may lead to huge losses if tech industry falls down.

3) YES, Erin made good financial decision because hedge funds do manipulate their past returns.

Definitions and behavioral biases :

1) Self attribution bias

2) Loss aversion

3) Herding behavior

For true and false- The picture is not clear so unable to read it properly. Please re-send the picture and this will be answered as well.

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