Personal Finance 1st Edition by Jack R. Kapoor

Exercise 3

A Lesson from the Past

Back in 2000, Mary Goldberg, a 34-year-old widow, got a telephone call from a Wall Street account executive who said that one of his other clients had given him her name. Then he told her his brokerage firm was selling a new corporate bond issue in New World Explorations, a company heavily engaged in oil exploration in the western United States. The bonds in this issue paid investors 8.9 percent a year. He then said that the minimum investment was $10,000 and that if she wanted to take advantage of this “once in a lifetime” opportunity, she had to move fast. To Mary, it was an opportunity that was too good to pass up, and she bit hook, line, and sinker. She sent the account executive a check—and never heard from him again. When she went to the library to research her bond investment, she found there was no such company as New World Explorations. She lost her $10,000 and quickly vowed she would never invest in bonds again. From now on, she would put her money in the bank, where it was guaranteed.

Over the years, she continued to deposit money in the bank and accumulated more than $42,000. Things seemed to be pretty much on track until her certificate of deposit (CD) matured. When she went to renew the CD, the bank officer told her interest rates had fallen and current CD interest rates ranged between 1 and 2 percent. To make matters worse, the banker told Mary that only the bank’s 60-month CD offered the 2 percent interest rate. CDs with shorter maturities paid lower interest rates.

Faced with the prospects of lower interest rates, Mary decided to shop around for higher rates. She called several local banks and got pretty much the same answer. Then a friend suggested that she talk to Peter Manning, an account executive for Fidelity Investments. Manning told her there were conservative corporate bonds and quality stock issues that offered higher returns. But, he warned her, these investments were not guaranteed. If she wanted higher returns, she would have to take some risks.

While Mary wanted higher returns, she also remembered how she had lost $10,000 investing in corporate bonds. When she told Peter Manning about her bond investment in the fictitious New World Explorations, he pointed out that she made some pretty serious mistakes. For starters, she bought the bonds over the phone from someone she didn’t know, and she bought them without doing any research. He assured her that the bonds and stocks he would recommend would be issued by real companies, and she would be able to find a lot of information on each of his recommendations at the library or on the Internet. For starters, he suggested the following three investments:

1. AT&T Broadband corporate bond that pays 9.455 percent annual interest and matures on November 15, 2022. This bond has a current market value of $1,530 and is rated BBB.

2. John Deere Capital corporate note that pays 5.35 percent annual interest and matures on April 13, 2018. This bond has a current market value of $1,190 and is rated A.

3. Procter & Gamble common stock (listed on the New York Stock Exchange and selling for $76 a share with annual dividends of $2.25 per share).

According to Mary Goldberg, the chance to invest in New World Explorations was “too good to pass up.” Unfortunately, it was too good to be true, and she lost $10,000. Why do you think so many people are taken in by get-rich-quick schemes?