A GAME OF INVESTMENT STRATEGY: DESCRIPTION, USE, CRITICISM AND MODIFICATION Insights into Experiential Pedagogy, Volume 6, 1979 81 A GAME OF INVESTMENT STRATEGY: DESCRIPTION, USE, CRITICISM AND MODIFICATION Abderrahman Robana, Alfred University William D. Biggs, Alfred University ABSTRACT The purpose of this paper is to discuss changes made to the computerized business simulation, INSTRAT: An Investment Management Simulation [2]. These changes were made to make the simulation more useful in terms of realism and in terms of the application of theoretical models to decisions in the simulation. The changes made to the simulation and the theoretical implications of these changes will be discussed. THE INSTRAT SIMULATION INSTRAT is an investment decision simulation. Students playing the game focus their attention on three decisions involved relative to one fixed income security (bond) and nine variable income securities (stocks). Specifically, students must decide: (1) the number of securities to buy or sell in a given period; (2) the number of securities to sell short or purchase to satisfy a short position; and, (3) whether or not to purchase certain types of market information. These decisions are not made in a vacuum since the game is competitively interactive. A brief description of the securities involved as provided in the original simulation is as follows: 1. National Telephone, which is a bond for which historical prices vary inversely with market yield as influenced by supply and demand for the bond. 2. Technological Innovators. Inc., which is a growth stock, paying small dividends and whose historical prices ranged from $70 to $125 with a Constant yield of 1%. 3. Beizer Land Investments, which is a speculative stock, with zero average yield and historical price range from $35 to $130. 4. Ball Mutual Fund with a high dividend payout and whose portfolio consists of common stocks in chemicals, oil, drug, steel and electric light and power. Its historical prices ranged from $80 to $115. 5. Clifton Power and Light Company, which is a growth stock with a high constant yield stock with moderate historical growth performance. The company is subject to government regulations and environmental controls. Share prices ranged from $90 to $110. 6. Tundra Oil and Gas, Ltd., which is a foreign concern involved in oil exploration and development with oil reserves potential of 50 billion barrels. The stock is speculative as reflected by its erratic price fluctuation ranging from $35 to $130, a zero average yield and a zero dividend payout. 7. Inter-city Transportation company, which is a speculative growth stock with a very low average yield and dividend payout. Prices range from $70 to $135. 8. Nadar Motor Company, which is a speculative stock with a relatively low yield and a long term growth potential. Stock prices ranged from $70 to $130. 9. Uranium Expeditions, Inc., which is a speculative high yielding stock. The company is subject to strict environmental controls and political decisions on Nuclear weapons. Prices ranged from $70 to $130. 10. Crank-Cam Auto Parts stock, which is a medium yield, medium growth investment whose prices range from $50 to $130 with a steady growth. In making their decisions, the players are subject to such real- life conditions as penalties If they purchase securities beyond their borrowing capacity plus their accumulated wealth. The feedback received by each player each period consists of: 1. A statement of securities purchased and held with market price and market value indicated. Also included is information concerning the players’ short position. 2. A cash flow statement. 3. A statement of margin account which indicates any unused borrowing capacity. 4. A statement of changes in wealth. 5. A statement of general information such as margin requirements. 6. A list of messages. The players submit their decision, receive the above indicated items and submit another set of decisions. Thus, the players must make short and long run oriented decisions which are sequential in nature with which they must live. THE USE OF INSTRAT PRIOR TO REVISIONS Prior to revision of INSTRAT, students started their investment decisions with the sane initial wealth of six thousand dollars and by the end of the simulation (15 decisions) all of the participants realized large capital gains. Moreover, gains were realized on each decision made by each student regardless of how bad their choices were. This, of course, is contrary to a real-life situation where some investors win and others lose. The reason for the above result was found in the original INSTRAT program which consistently produced a bull market condition. In turn, this encouraged students to refrain from selling short and only normal or regular purchases and sales of securities were made. This situation eliminated all risk situations and the game became monotonous to the participants. SOME SHORTCOMINGS OF INSTRAT Our initial use of INSTRAT indicated that the simulation suffered from several shortcomings. First, the random number mechanism used to determine whether a bear or bull market would result was faulty; the method used generated a bear market about 15 percent of the time and a bull market about 85 percent of the time. This situation lacks historical support and therefore should be changed. The percentage of bear and bull markets from 1948 to 1977 actually was approximately Insights into Experiential Pedagogy, Volume 6, 1979 82 45 percent and 55 percent respectively [1]. Second, the game as formulated implies a backwards relationship between payout ratios and prices in that a constant payout ratio is used which implies that price determines earnings rather than the reverse. Third, stock splits automatically occur whenever the price of the security reaches $150; a situation which hardly conforms to reality. Finally, despite the fact that the game is interactive it is devoid of market psychology for players are not supposed to know each others’ decisions. In addition, other aspects of market psychology, such as erroneous information, are missing. These limitations all detract from the realism of INSTRAT and therefore tend to diminish student interest. SUGGESTED CHANGES To correct these deficiencies a number of changes are recommended. First, the calculation of bear and bull markets needs to be changed. We have made this change by rewriting the simulation to permit the instructor to decide whether or not a bear or bull market will occur as well as whether or not a bear or bull market is expected. Thus, the instructor can wore closely replicate historical data (13 bear and 16 bull market conditions from 1948 to 1977) and introduce change to maintain student interest. The computer statement changes necessary to make this modification are indicated in Appendix I. It should be noted that Appendix I also includes changes to print our decision cards which contain zeros. This ehange makes it easier to punch decisions since frequently zeros are entered and since the field specifications are identified. Second, we suggest that the constant payout ratio be changed to remove the Implication that price causes earnings. Perhaps this change is not as necessary as the previous one since dividend policies of organizations are sometimes based upon a constant percent of income approach. However, it is also frequently true that dividend policies call for a constant payout in absolute terms which results in a variable payout in terms of earnings. This change could be introduced by having some of the stocks maintain a constant payout in absolute terms unless changed by the instructor. Since we have not completed the programming changes involved here we cannot provide a list of modifications to be made to the simulation at this time. Third, the automatic stock split should be changed. This change could be accomplished by using past historical data to create a realistic stock split generator which is randomly accessed each period. For example, if stock selling in the $10 to $20 price range has a .01 chance of splitting, this probability could be used. Again, at this time this modification has not been made. Finally, market psychology and real world replication could be used in a variety of ways. First, information concerning economic conditions which are real world oriented could be provided each period. For example, a market expectation indicator that corresponds to those available in the real world cou’d be used. Second, individuals could be provided with information concerning the decisions of other real (i.e., game players) and hypothetical players. Third, the hypothetical stock codes currently used in the simulation could be replaced by real stock codes and perhaps even by real world dollar values for each stock. All of these changes tend to make the simulation more realistic and to increase student interest. Such interest appears to contribute to motivation and learning. USE OF THE MODIFIED SIMULATION In this section we will discuss some of the results which occurred when the simulation was used with the bear-bull market indicator modification introduced. Participants in the modified INSTRAT version became more interested in the simulation and they exhibited an interest to compete more keenly in the class as they realized that both normal and short sale trans- actions could be ruinous or fortunate depending on the actual outcome of bull or bear markets which the manager of the game could now control. To minimize their risk, participants started to think in terms of risk-return trade off [3, 4]. Students tabled their own calculation of standard deviations or coefficients of variation of their total returns from historical data before making a final security selection. The total returns used were derived from holding period rates of return for both individual securities and the market. The estimates were derived from historical data applied to the total return formula which includes capital appreciation or (losses) plus dividend yields: HPR = Pt - Pt-1 + Dt/ Pt-1 where: Participants used returns as the basis for estimating future holding period prices and adjusted their forecasts according to information INSTRAT allows them to buy. Based on the information bought, participants formulated subjective probabilities to be applied to the securities holding period returns to get expected returns on each individual security and the expected return on the portfolio which is a weighted average of the expected returns on its securities. By going through these calculations holding period return and risk, students started to formulate strategies for diversifying their portfolios based on whether the returns are positively correlated, uncorrelated or negatively correlated. The above framework provided students with the conceptual basis for analyzing investment alternatives. However, from a fractional point of view, students realized that calculating expected returns and variance-covariance of security returns is a drudgery since the Markowitz model [5] is complex and requires many computations in determining the effect on every possible investment alternative. It is here that students appreciate the simplification brought up by Sharpe in his Index model or capital asset pricing model [6]. Here students examine the relationship between a security prospect and those of the market using a characteristic line [7]: R - P = + B. (R -P) + r, where: m 1 Insights into Experiential Pedagogy, Volume 6, 1979 83 integrating the above model in INSTRAT the simulation becomes more of a portfolio strategy or “PORTSTRAT” based on calculating the alphas and betas of the securities as well as adjusting these as conditions warrant. The participants’ strategies are reflected through their portfolios’ betas which indicate what aggressive or defensive market posture they took. Student’s performance is measured by the ending wealth as well as the ratio of reward to risk exposure as measured by Sharpe’s or Treynor’s performance measures using portfolios’ excess return over a riskless rate divided by either the market risk as measured by beta (reward to volatility) or the total risk as measured by the standard deviation (reward to variability). Once the above framework is followed, participants could systematically distinguish between undervalued securities and overvalued ones. An undervalued security exists when its expected return is greater than that commensurate with the level of risk involved (risk measured by either the standard deviation of returns or by beta). An overvalued security exists when its expected return is less than that commensurate with the level of risk involved. Once the participants determine undervalued and overvalued securities, they could then efficiently buy and sell securities and revise their portfolios accordingly. Following the above procedure, participants will accomplish the following educational objectives: 1. Selection of the appropriate types of securities for analysis based on expected risk- return trade-off. 2. Portfolio mix and revision. 3. Performance evaluation. Thus, in addition to stimulating student interest, the modified INSTRAT or “PORTSTRAT can serve as a useful teaching device implementing several important and practical aspects of investing. Despite our belief that replacing the hypothetical stocks with real stock codes and data would increase student interest-- motivation--learning, we elected not to make this change for four reasons. First, the industry diversification of securities as provided in INSTRAT is reasonable. Second, the data currently provided would be of no use and other program changes would be necessary. Third, students, given real stock codes and data, might be inclined to look at what actually happened to the stocks and make decisions based upon historical facts rather than analysis. Fourth, changing the codes might only deceive the students into thinking that real data was also being used, which again might cause decisions to be made upon presumed historical facts rather than analysis. We did provide students with more information about the decisions of other real and hypothetical players. This information permitted the students to engage in more sophisticated analysis and appeared to generate greater interest. CONCLUSION The modifications actually completed at this time have contributed to student interest--motivation--learning. We believe that the other changes recommended in this paper need to be made to make INSTRAT an even better simulation. These changes, however, need to be added sequentially so that the effects can be assessed. Insights into Experiential Pedagogy, Volume 6, 1979 84 Insights into Experiential Pedagogy, Volume 6, 1979 85 REFERENCES [1] “Cyclical Indicators”, Business Condition Digest, October, 1977, p. 14. [2] Gitman, L. J., INSTRAT: A Game of Investment Strategy (Morristown, N.J. General Learning Press, 1974). [3] Hodges, S. D. and R. A. Brealey, Portfolio Selection in a Dynamic and Uncertain World,” Financial Analyst Journal, Vol. 29, 1973, pp. 50-55. [4] Hodges, S. D. and R. A. Brealey, “Using the Sharpe Model,” Investment Analyst, Vol. 27, 1970, pp. 41- 50. [5] Markowitz, M. Harry, Markowitz Revisited,” Financial Analyst Journal, Vol. 32, 1976, pp. 47-52. [6] Sharpe, W. F., “A Simplified Model for Portfolio Analysis,” Management Science, Vol. 9, 1963, pp. 277-293. [7] Sharpe, W. F., “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk, The Journal of Finance, Vol. 19, 1964, pp. 425-442. We are indebted to Mr. Stan Munson who made the program changes. Table of Contents Volume 6, 1979 The Use of Cases with Role Plays in a Research Methods Course Debugging and Implementing the Live-Case Approach to Marketing Research in the Australian Environment Using a Case as the Basis for a Modified Debate Using Cases in Business Communication Classes A Structured Approach to Case Analysis and Reporting Intercollegiate Case Analysis Competition as an Experiential Learning Experience Attributes Germane to Student/Live Case Situations Understanding Dispute Resolution Through Experiential learning Personality Development and Conflict Dynamics: An Experimental Design to Study the Effects of Teaching Methodologies on Conflict Resolution Interpersonal Competence and the Digital PDP-11:40 The process of Writing a Collective Bargaining Simulation: A Case Study in Practical Pedagogy Simulating Negotiations in an Educational Context Simulations as a Technique for Teaching Collective Bargaining Experiential Processing of Differing Managerial Perspectives: The Use of a Game Show Format Individual Self Report vs. Group consensus in Small Decision-Making Groups Effects of Sex-Role Stereotypes on Promotion Decisions: An Exercise Computer Aids to Planning: The Budget and Forecasting Module Use of a Microcomputer in a Decision Analysis for Investment Portfolio Selection A Game of Investment Strategy: Description, Use, Criticism and Modification Coping with Future Uncertainties Through Probabilistic Budgeting Administration and Design of Simulation Materials for a Specialized Management Training Program Managing Stress in Organizational Life Banksim: The Bank Management Simulation Issues in the Organizational Application of Simulation and Experiential material Games Within Games: The Role of the Glitch Experiential Learning from Classroom to Business An Evaluation of the Small Business Institute Program as an Experiential learning Exercise Conversations with Top Management (Simulated) Experience in the Use and Assessment of Simulation in Management Education A Statistical Analysis of Simulation Users: Relationships between Stress and Human Subject guidelines Group Decision Making in a Computer Game Analysis of Demographic and Psychosocial Variables Comparing Performance During Three Managerial Accounting Simulation Schedules Business Policy Simulation and the Intense Course Structure The Use of Intensive Simulation in Executive Development and Academic Settings The Use of Experiential Exercises in the Undergraduate Consumer Behavior Course A Personal Marketing Strategy Approach: Framework and Application Teaching PERT Experientially in Marketing Research Discovering the Majority Fallacy An Experiential Approach to Studying International Business A Demonstration of the Business Simulation Game as a Curriculum Assessment Device Relating Teaching Methods with Educational Objectives in the Business Curriculum The Junior Achievement Applied Management Program as a Compromise Situation Between the Simulation and the Internship Who is Using Computerized Business Games?: A View from Publishers' Adoption Lists Trials and Tribulations in Testing Educational Innovations An Examination of the Perceived Effectiveness of Computer Simulation in a Classroom Setting as Affected by Game, Environmental and Respondent Characteristics Game Administration: A Life Cycle Analysis Research on the Effectiveness of Using a Computerized Simulation in the Basic Management Course Gaming and Attitudinal Change The Teacher-Student Relationship in Experiential Classes and the Student's Perception of Course Effectiveness An Exploratory Study of Student Characteristics and Educational Processes in Programmatic Experiential learning General Incongruity Adaption Level (GIAL) as a Predictor of Risk Preferences in a Simulated Management Game The Cap-Stone Opportunity: Combining Business Simulation and Experiential Learning Incorporating MIS/DSS into Policy Courses Via Simulation Who Benefits Most from Participation in Business Policy Simulations: An Empirical Study of Skill Development by Functional Areas The Use of Program NAMEX in Teaching the Accounting for Nonmonetary Assets The Use of Program CVP in Teaching Cost-Volume-Profit Analysis Experiential vs. Traditional Classroom Approach in the Basic Management Course: A Puerto Rican Experience A Guide to the Successful Use of Business Simulation Games The Dynamic Aspects of Interactive Gaming Puts the Realism into Gaming System Representation of SIMORG The Design of a Database System to Support Business Simulation and Experiential Learning A Data Entry and Retrieval System for a Computer Simulation (DERS) Simulation - An Advantage for Accounting Research Computer-Aided Project Performance Control Simulation: An Interactive Experiential Gaming Technique for Managerial Decision Making Utilization of Manual Simulation Games to Develop Scenarios of Future Events - An Exploratory Study Foundry: A Foundry Simulation Customized Debriefing: The Achilles Heel of Experiential learning? Computerized Business Simulations and Experiential Learning Exercises: An Instructional Interface The Baseball Game: A Group Role Observation, Problem Solving Experience A Practical Design for Experiential Learning Exercises: Roles, Technical Equipment and Alternative Debriefing Formats