Chapter 5 Mutual Funds and Hedge Funds

Question 1

Mutual Funds

Answer 1

Financial institutions that pool the resources of many investors by selling them shares of the fund and using the proceeds to purchase other assets, such as bonds, stocks, and other securities.

Question 2

Traditional features of mutual funds include

Answer 2

1) Not traded on exchanges
2) Investors purchase mutual fund shares from the fund itself, not other brokers
3) The price paid by investors is the mutual fund’s NAV plus other fees imposed by the fund
4) Mutual funds can be redeemed at any time; liquid

Question 3

Mutual funds are attractive because

Answer 3

1) Managed professionally
2) Diversification
3) Denomination intermediation: Small investors can participate in markets that require large denominations

Question 4

Mutual funds are not attractive because

Answer 4

1) Fees and costs

2) Lack of control: Investors cannot choose to sell a stock or buy a stock in the portfolio

Question 5

Types of mutual funds

Answer 5

There are four types:

1. Bond funds
2. Equity funds
3. Money market funds
4. Hybrid funds (mix of bonds and equities)

Question 6

What are money market funds and some examples of money market instruments?

Answer 6

Money market funds invest in money market instruments that are short-term, liquid, and low risk. Some money market instruments include: Treasury bills, European CDs, Commercial Paper, and Bank Notes.

Question 7

Index Mutual Funds

Answer 7

Mutual funds that buy securities in proportion to those held by the index in order to match the performance of the market.

Question 8

Stock Market Index

Answer 8

A composite value of a group of exchange-traded funds

Question 9

Net Asset Value

Answer 9

The per-share value of a mutual fund that is calculated by subtracting the fund’s liabilities from its assets’ market values, then dividing it by the total number of shares outstanding.

Question 10

Explain the types of mutual fund fees

Answer 10

1) Sales load: Fees that are imposed at the time of purchase (front end load) or at the time of redemption (back end load)
2) Fund operating expenses

The expense ratio earned by funds are expressed as annual operating expenses as a percentage of the fund’s net assets.

Question 11

What are some mutual fund regulations?

Answer 11

1) Typically cannot sell short
2) Typically cannot purchase on margin
3) Typically cannot invest in derivatives
4) Must disclose its portfolio holdings quarterly

Question 12

Hedge Funds

Answer 12

Hedge funds are financial institutions that invest for wealthy individuals and institutional investors (pension funds)

Question 13

Features of Hedge Funds

Answer 13

1) Hedge fund shares are not available to the general public
2) Hedge funds can use a variety of aggressive trading strategies
3) Hedge fund shares are illiquid. Hedge funds allow redemptions only at year-end and require a two-month notice

Question 14

Hedge Fund fees

Answer 14

Management fees are typically expressed as a percentage of total AUM
Performance fees are expressed as a percentage of any positive net profits generated by the hedge fund

Question 15

What is 2 and 20?

Answer 15

2 and 20 is a fee structure used by hedge funds. 2% management fees and 20% performance fees