Behavioral
Finance: Application to Risk
This exam consists of two parts. Part 1 is worth 75
points and Part 2 is worth 25 points.
Part 1 pertains to the recent data breach at the
firm Equifax, and Part 2 pertains to the target price for Facebook stock
developed by sell side analysts at Morgan Stanley.
There is an answer template file for the exam.
Please answer in the template file, and add your name to the template file when
submitting.
Please remember that this exam is to be done
INDIVIDUALLY, not in groups, or in communication with anyone else.
Part
1. Equifax
The questions in Part 1 of the exam are based on
information which is provided in a series of articles whose links appear below.
Your task in Part 1 of the exam is to be
able to identify and distill a small set of behavioral issues from a long,
complicated narrative. The links describing the narrative are as follows:
Answer the specific questions below. Your answers
should be short, crisp, to the point, and focused on answering the questions.
Resist the temptation to write long essays that purport to show everything you
have learned in the course. As you answer each question, keep in mind that you
are being asked to discuss how a series of behavioral concepts apply to the
Equifax case. Therefore your answers need to:
1. explicitly
identify key behavioral concepts;
2. demonstrate
that you understand these concepts;
3. apply
the concepts successfully to the Equifax case, by describing how the concepts
specifically relate to key details of the case.
1. Slide 2 of the lecture for Day 2 of the
behavioral finance course describes a matrix summarizing the process-pitfall
framework. In the context of the
process-pitfall framework, write down what you consider to be the four most important cells. Answer the
question by placing four numbers in the matrix below, with 1 being what you
consider to be the most important cell.
2. Given your answer to question 1, identify what
you would judge to be the most important issue pertaining to the psychology of
risk, at the level of the individual. Explain your answer in a few sentences (5-10 sentences), being sure to
indicate how your answer pertains to the information provided in the articles
about the Equifax breach.
3. Given your answer to question 1, identify what you
would judge to be the most important issue pertaining to heuristics and biases,
at the level of the individual? Explain your answer in a few sentences (5-10 sentences), being sure to
indicate how your answer applies to the information provided in the articles
about the Equifax breach.
4. Given your answer to question 1, identify what you
would judge to be the most important issue pertaining to risk styles, at the
level of the individual? Explain your answer in a few sentences (5-10 sentences), being sure to
indicate how your answer applies to the information provided in the articles
about the Equifax breach.
5. Chapter 6 of the book Behavioral Risk Management and chapters 9 and 11 of the book Behavioral Corporate Finance focus on
frameworks for analyzing organizational issues, especially those associated
with risk management. Given your answer to question 1, which pertains to
process-pitfall, identify which other important conceptual frameworks pertain
to group and organizational decision issues associated with the Equifax case.
Begin your answer to this question by naming two
behavioral organizational concept which you regard as being the most relevant,
besides process-pitfall. After identifying the conceptual frameworks, discuss
how your answer pertains to the information provided in the articles about the Equifax breach.
Part
2. Target Price for Facebook
Day 2 PM of the behavioral finance course includes a
discussion about growth opportunities bias. An application of this concept to
Amazon stock can be found at https://www.forbes.com/sites/hershshefrin/2017/10/01/credit-suisses-mistaken-amazon-valuation-is-but-the-tip-of-the-iceberg/#2a2cb6f33995.
Part of the material for this exam is a Morgan
Stanley report on Facebook, dated July 27, 2017. The April report contains a
DCF analysis. Analyze the DCF analysis in this report for the presence of
growth opportunities bias.
1. Compute Facebook’s perpetual growth rate
associated with the terminal horizon that would lead the firm to earn its cost
of capital exactly during the terminal horizon, given the other assumptions in
the Morgan Stanley report. Write down any formulas that you use, and show your
work.
2. The target price
valuation of Facebook’s stock, given that Facebook will be expected to earn its
cost of capital exactly during the terminal horizon. To arrive at this value,
fill in the table below, whose items appear in the Morgan Stanley DCF analysis.
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