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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Basics of Behavioural Finance

Caselet: Ms. Anita Rao received a Rs 5 lakh bonus. She keeps it in a savings account at 3% 'for fun spending' while simultaneously carrying a personal loan at 14% and refusing to use the bonus to prepay it, calling the bonus 'free money'. In the efficient-market, rational-agent view, which concept does her behaviour most directly violate, and what is the appropriate adviser response?

Her behaviour violates the fungibility of money through mental accounting. The adviser should demonstrate that using the bonus to prepay the 14% loan saves far more than the 3% savings account earns, a guaranteed gain, while allowing a small planned amount for spending if desired.

  1. AFungibility of money; the adviser should show that prepaying the 14% loan gives a higher risk-free return than 3%Correct
  2. BFungibility of money; the adviser should accept her buckets because emotions override finances
  3. CDiversification; the adviser should move the bonus into equity shares
  4. DTime value of money is irrelevant here; the adviser should leave the loan untouched

Explanation

Treating bonus money as separate from other money is mental accounting, violating fungibility (money is interchangeable). Prepaying a 14% loan yields a guaranteed 14% saving versus 3% earned, so showing this gap is the appropriate response. Moving money to equity adds risk and does not address the issue.

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