The Damon Investment Company manages a mutual fund composed mostly of speculative stocks. You recently saw an ad claiming that investments in the funds have been earning a rate of return of 21%. This rate seemed quite high so you called a friend who works for Damons competitors. The friend told you that the 21% return figure was determined by dividing the two-year appreciation on investments in the fund by the average investment. In other words, $100 invested in the fund two years ago would have grown to $121 ($21/$100 = 21%).
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The Damon Investment Company manages a mutual fund composed mostly of speculative stocks. You recently saw an ad claiming that investments in the funds have been earning a rate of return of 21%. This rate seemed quite high so you called a friend who works for Damons competitors.
The friend told you that the 21% return figure was determined by dividing the two-year appreciation on investments in the fund by the average investment. In other words, $100 invested in the fund two years ago would have grown to $121 ($21/$100 = 21%).
In the ad, you saw that the Damon Investment Company manages a mutual fund composed mostly of speculative stocks. You recently saw an ad claiming that investments in the funds have been earning a rate of return of 21%.
This rate seemed quite high so you called a friend who works for Damons competitors. The friend told you that the 21% return figure was determined by dividing the two-year appreciation on investments in the fund by the average investment. In other words, $100 invested in the fund two years ago would have grown to $121 ($21/$100 = 21%).
The friend told you that the 21% return figure was determined by dividing the two-year appreciation on investments in the fund by the average investment.
The friend did not tell you that this calculation was based on an unverifiable assumption; instead, it was based on an explicitly stated fact: “The average rate of return for our funds over a period of time.” In other words, if you want to know how much money Damon Investment Company has made lately, just look at their website and see what they said about themselves there! By looking at their own website we can see that they’re making lots of money! We don’t need any other information because everything is right here: http://www.damoninvestmentcompany.com/faqs
The 21% return figure is not a true rate. It’s an annualized rate and does not take into account compounding or real interest rates. For example, if you invested $100 two years ago and earned a real 6% per year for that period, then your investment would have grown to $121 ($21/$100 = 21%). This is different from the headline claim made by Damon Investment Company—that their funds returned 21%.
To recap, the Damon Investment Company is misrepresenting its performance by claiming a 21% return. This is not accurate and should be investigated for fraud.
The first thing to consider is whether or not it’s ethical for an investment company to make such a claim without providing proof that it’s true. Let’s say you’re working at an office where you have access to your boss’ financial records, which show that the previous year the company lost money instead of making money (which is what would happen if its investments were doing well). You could use this information as evidence against Damon’s claim that investors have earned 21%. But even though there are plenty of reasons why investors might lose money in any given year—or even decade—that doesn’t mean we should accuse them all of being frauds simply because they didn’t win big last week!
In this case, the Damon Investment Company made a claim about the performance of its funds that was not completely accurate. The ad claimed that its mutual funds had performed 21% over two years, but as we saw above, this was determined by dividing the appreciation on investments in the fund by their average investment. In other words, $100 invested two years ago would have grown to $121 ($21/$100 = 21%).
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