FINA 351 – Managerial Finance (Ref. 10a)
Read the textbook and notes for Chapter 10 and answer the following questions:
1.
According to Mark Twain, which month of the year is the safest in which to speculate in stocks? See
your textbook.
2.
Correctly calculating return on investment (ROI) is an important exercise, as illustrated by the
Beardstown Ladies fiasco. Read their story at the end of this document and answer the following
questions:
(A) T or F: The Beardstown Ladies claimed that their investment club returned 14.9% over a 10-year
period, which was considerably more than the S&P500’s return of 9.1% over the same period.
(B) T or F: Although the Ladies admit their returns were not as great as initially claimed, the Ladies
today continue to be wildly popular as they visit the TV talk shows and publish new best sellers on
homespun investing strategies.
3.
Suppose a stock had an initial price of $50 per share and paid a dividend of $3 during the year. If the
price of the stock rose to $60 per share at the end of the year, find the
(A) annual dividend yield
(B) annual capital gains yield
(C) total annual nominal percentage return
(D) total annual real return if inflation is 3% (approx. method).
4.
Suppose a stock had an initial price of $40 per share and paid a dividend of $4 during the year. If the
price sunk to $30 per share at the end of the year, find the
(A) annual dividend yield
(B) annual capital gains yield
(C) total annual nominal percentage return
(D) total annual real return if inflation is 3% (approx. method).
5.
Suppose that one year ago you bought one 30-year term bond (face value = $1000) that pays annual
coupons of 10% for price of 95. If today the bond is selling for a price of 94, calculate the
(A) annual current yield
(B) annual capital gains yield
(C) total annual nominal percentage return
(D) annual real return if inflation was 3% (approx. method)
6.
(A) Which is more risky? Investment A or B (shown below)? Why?
(B) T or F: Variance or standard deviation measures risk.
7.
(A) Using Table 10.1, find the highest and lowest returns for each of the following and then record the
year and the high/low figures: Large-Co. Stocks, L/T Gov. Bonds, US T-Bills. (Hint: also see Figures
10.5, 10.7 and 10.8).
(B) Which of these three investments appears to have the most volatile returns?
(C) Which investment appears to have the most stable returns?
(D) Given that it’s more risky, why would a financial planner recommend large-co. stocks over T-bills
for a 24-year-old’s retirement plan?
(E) Were there any years during which the nominal return was less than the real return for T-bills? (Hint:
inflation is negative). If so, list one.
(F) Were there any years when U.S. T-Bills had a negative real return? If so, list one.
(G) Why do you think T-Bills had high nominal returns in the late seventies and early eighties?
8.
(A) Review Figure 10.10. If small stocks have the highest average return over the years, why doesn’t
everyone just buy small stocks?
(B) Explain what a risk premium is.
(C) T or F: The more volatile the returns, the higher the standard deviation, which means an increased
chance of getting a negative return, which means more risk . . . thus, standard deviation measures risk.
(D) T or F: Investments with a spread-out, flat distribution are more risky than ones with a tall, narrow
distributions.
9.
Read Section 10.5 in your chapter. Suppose that four years ago you paid $100 for a stock (no dividends)
that had the following returns over the next four years:
Year 1
Year 2
Year 3
Year 4
32%
10%
5%
-10%.
(A) What is the return in an average year over this four-year period (arithmetic average return)?
(B) What is the average compound return per year over these four years (geometric average return) and
what is the price of your stock today?
(C) Which of these average returns (geometric or arithmetic) do you think is more accurate or relevant?
(D) Which of these two types of average returns (geometric or arithmetic) is the default meaning for
“average return” as used by your textbook and the financial press?
10.
The Vanguard Group operates one of the largest families of mutual funds, with over 100 different fund
choices. Vanguard was founded by John Bogle, who is to mutual funds what Warren Buffet is to stocks.
Bogle wrote the bestseller classic, Common Sense on Mutual Funds. Listed below in no particular order
are a few of the funds offered by Vanguard. Rank the funds from the most riskless to the most risky. If
you doubt your ranking, you can check it at https://investor.vanguard.com/mutual-funds/vanguardmutual-funds-list?WT.srch=1
(a) large cap (big company) growth fund
(b) long-term non-investment grade corporate bond fund
(c) small cap (small company) growth fund
(d) short-term Treasury fund
(e) long-term investment-grade corporate bond fund
(f) long-term Treasury fund
(g) large cap high dividend yield fund
11.
Review the graph on the below.
(A) What would have been the approximate annual minimum and maximum returns if you had held the
30 stocks in the Dow for 2 years? For 20 years?
(B) Is it more risky to hold a stock portfolio for 2 years or 20 years? Why?
(C) The Social Security Trust Fund invests exclusively in U.S. Treasury securities, which are earning less
than 2.0% on average right now. Many people think that Social Security funds should be invested in nonTreasury investments, including stocks, which can earn much higher returns over time. President Obama
opposes investing Social Security funds in the stock market, which would “subject Americans guaranteed
retirement income to the whims of the stock market.” Do you agree with President Obama that investing
long-term retirement funds in stocks is too risky? Why or why not?
Beardstown Ladies
In November 1983, 16 elderly women (average age of 70) gathered together in Beardstown, Illinois
(pop. 5800), to start an investment club. In 1994, they claimed that their no-nonsense investing style
earned them a 23.4% annualized 10-year return (1984-1993). This led to a book called The Beardstown
Ladies' Common-Sense Investment Guide, which spent three weeks on the best-seller list. The ladies
took the investing world by storm and became the champions of the individual investor. Their apparent
success and folksiness made them popular guests on many TV shows. Thousands turned out to see
them speak, and investment clubs flourished like toadstools, especially women’s investment clubs. They
would appear on The Today Show and Good Morning America and people would say, “If they can
invest and be successful, I can, too.”
Fifteen years and five books later, in March of 1998, the Beardstown Ladies were exposed by a financial
journalist as not having correctly calculated their average return. Their actual return annualized over a
10-year period was 9.1%, far below the 23.4% initially claimed, and also below the S&500 return of
14.9% over the same period. The Ladies had inadvertently included the new investments made by
members as part of their return. The Ladies hired the CPA firm of Price Waterhouse Coopers to
independently calculate their return, which was indeed confirmed to be only 9.1%.
This was a sad day for the Ladies and a shock to the investing world. The fall was abrupt. Time
magazine (kiddingly) suggested that the Ladies be jailed. The publisher of their book, Hyperion, faced a
class action lawsuit and took the Ladies’ books out of print. The lawsuit was eventually settled by
offering to swap any Beardstown book for some of the publisher’s other titles, including 116 Ways to
Spoil Your Dog. Only used copies of the Ladies’ books are available now, on Amazon.com and eBay,
often for pennies.
But while a shocked and disappointed public turned its back on the Beardstown Ladies, nobody really
paid much attention to another number the outside auditor had discovered: that the club’s average annual
return from 1983 to 1997 was 15.3%, outpacing the Dow and the club’s own infamous 1984-93 returns.
Eventually, the ladies did have their revenge. When others lost their shirts in the dot-com bust, their
plain-vanilla investments didn’t do so badly. Every investor it seems lost money but the Ladies’ losses
were less than a lot of others because, like Warren Buffet, they had begun to pay close attention to
fundamentals.
Today, the Ladies are still spreading their fundamentalist gospel, albeit it in a much more low-key and
quiet manner. Of the group’s 16 founders, eight have died and two left for health reasons, but new
members have joined. They still meet monthly, joined occasionally by fans from as far away as Japan.
They still buy and hold stocks for the long haul, and they still have those old Wal-Mart and Medtronic
stakes. Among their more recent buys have been the appropriately homey Bed Bath & Beyond and
Cheesecake Factory.
But gone are the days when they were the talk of the nation. Today the Ladies are happy to live their
quiet lives in relative obscurity. Though the Beardstown Chamber of Commerce still features the Ladies
prominently on its Web site -- almost as prominently as Abraham Lincoln, who won a court case in
Beardstown as a young lawyer – the Ladies are not exactly treated like rock stars, especially at home.
Eighty-eight-year-old Doris Edwards (charter member and current club President) says that a lot of the
things that happened the people in Beardstown have no idea about. You have to get at least 50 miles
away from home before anyone knows about the things that made the Ladies famous and infamous.
Beardstown sounds a lot like College Place.