chapter 4 mutual funds mutual funds

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Chapter 4 Chapter 4 Mutual Funds Mutual Funds

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Post on 05-Dec-2014




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  • Chapter 4Mutual Funds

  • Mutual FundsOur goal in this chapter is to understand the different types of mutual funds, their risks and returns

  • Staggering StatsIn 1980, 5 million Americans owned mutual fundsBy 200193 million Americans owned mutual fundsMutual fund assets totaled $7 trillionYes, thats $7,000,000,000,000

    *As of October 2007, $12.3 trillion

  • Stocks vs. Mutual Funds$10,000 invested in individual stocksPay commissions on each stock purchasedPossible difficulty in diversification$10,000 invested in a mutual fundsPay bundled expenses through the fund for active managementDiversification

  • Mutual FundsMutual funds are Financial IntermediariesInvestment companies that pool the funds of a large group of investorsManaged by fund managers who make the buying and selling decisions

  • Organization and CreationA mutual fund is a corporationOwned by shareholdersCreated by investment advisory firmsFirms earn fees for managing mutual funds

  • Investment CompaniesRecord keepingPeriodic status reports are issuedDiversification and divisibilityInvestors can hold fractional shares of many stocksProfessional managementAnalysts and port. managers looking for superior investment resultsLower transactions costsBlock trading saves money on brokerage fees and commissions

  • Investment Companies and Fund TypesInvestment company business that specializes in pooling funds from individual investors and making investments

  • Investment Company ClassificationsUnit Investment TrustsNot actively managedInvest in relatively uniform types of assetsORManaged Investment CompaniesActively managed

  • Investment Companies and Fund Types

  • Investment Companies and Fund TypesOpen EndIssue and redeem shares at their net asset value (NAV)NAV = (market value of assets - liabilities)/shares outstandingOffering price may exceed NAV b/c of a loadClosed EndDo not issue or redeem sharesmust buy or sell shares to other investors (many traded at NYSE)Usually sell at a discountCan be traded all dayCan be traded on margin

  • Investment Companies and Fund TypesNet asset value (NAV) is the value of the assets held by a mutual fund, divided by the number of sharesShares in an open-end fund are worth their NAVShares of closed-end funds may differ from their NAV

  • Short-Term FundsMoney market mutual funds (MMMFs)Specialize in money market instrumentsMaintain a $1.00 NAV to resemble bank accountsCan be taxable or tax-exempt

  • Stock FundsCapital appreciation and dividend incomeCapital appreciationGrowthGrowth and IncomeEquity incomeCompany sizeSmall capMid-capLarge cap

  • Stock FundsInternationalGlobalEmerging marketsSector FundsBiotechnologyInternetEnergy

  • Stock FundsOther FundsIndex fundsSocially conscience fundsSin fundsTax-managed funds

  • Bond FundsGovernment debtCorporate debtTax-planned

  • Stock and Bond FundsFunds that do not invest exclusively in either stocks or bondsBalanced fundsWeighting of assets may be restrictedAsset allocation fundsFreedom in allocation between stocks and bondsConvertible fundsBonds and preferred stock that converts to common stockIncome funds

  • ValuationValuation is based on the net asset valueNAV is the value of each share in an investment company

    NAV = Market value of assets less liabilitiesShares outstanding

  • Fund ValuationGiven the data below, calculate the NAV for the fund below (#s in millions)AssetsLiabilities$13,857$1,522Shares outstanding: 313NAV =

  • Fund Rates of ReturnYou invested in a mutual fund with a $20 NAV. At the end of the year, the NAV rose 8%. A dividend of $0.20 was paid. What is the rate of return on your fund?NAV1 - NAV0 + Income/Div. DistributionsNAV0

  • Taxation of Investment CompaniesA regulated investment company does not pay taxes on its investment incomeTo qualify:Almost all assets in stocks, bonds and other securitiesMaintain a 50% diversified portfolio and use
  • Fund Prospectus and Annual ReportLegally required to supply a prospectus

    Must provide annual report to shareholders

  • Types of Expenses and FeesSales charges or loadsFront-end load - charged on purchaseBack-end load charged on redemption12b-1 feesMarketing and distributionSEC rule allows funds to spend up to 1%Management feesTrading costs

  • Types of Expenses and FeesManagement feesRange from 0.25%-1% of total assets each yearUsually tied to fund size or performanceTrading costsNot reported directlyTurnover must be reportedIncrease as turnover increases

  • Trading and TurnoverYour mutual fund holds the securities below:

    If the manager replaces Stocks B and D with shares of a new Stock, E, what is the turnover rate?








  • Expense ReportingRequired to report expenses in a standardized wayShareholder transaction expensesLoads and deferred sales chargesFund operating expensesManagement and 12b-1 feesAccounting, legal, reporting and director feesHypothetical example showing total expenses paid over time per $10,000 invested

  • How do loads affect your investment?Fee structure on your investment (assuming a 12% annual rate of return before expenses)Fund A - No load, .5% operating expenses, no 12b-1Fund B - No load, 1% operating expenses, .5% 12b-1Fund C - 8% load, 1% operating expense, no 12b-1


    Cumulative Proceeds

    Fund AFund BFund C

    Initial Inv.10,00010,0009,200

    5 yrs17,23416,47415,502

    10 yrs29,69927,14126,123

    15 yrs51,18344,71344,018

    20 yrs88,20673,66274,173

  • Why Pay Loads and Fees?Many good no-load funds existMany bad load funds existYou may wish to invest inA fund with a specific manager

    A fund that specializes in foreign companies

  • Exchange Traded FundsPrice movements are based on the value of the underlying indexOnly operating expensesDo not require active managementSubject to the bid-ask spreadClosed-end funds, can be traded all dayMust be purchased from brokers for a feePopular ETFsSpiderDiamondsCubes

  • Why Trade with ETFs?Mutual fundsReceive cash from investors and buys stocks with cashSells stocks to obtain cash when investor redeems sharesTrade only at NAV as priced at the end of each trading day

    ETFsCreate shares by depositing a portfolio of shares matching indexMargin eligibilityTradable throughout the day

  • Quick QuizWhy do people invest in mutual funds?What is the difference between a load and a fee?What is an ETF?