Invesments Ch 12 Flashcards
TYPES OF INVESTMENT COMPANIES
There are four basic types discussed in this chapter:
4 TYPES OF INVESTMENT COMPANIES
- Unit investment trusts (UITs)
- Closed-end funds (known as closed-end companies)
- Exchange traded funds (ETFs)
- Mutual funds (known as open-end companies)
Investment companies provide investors with easy access to capital
markets, including both individuals and institutional investors.
Investment companies provide investors with easy access to capital
markets, including both individuals and institutional investors.
INVESTMENT COMPANY CHARACTERISTICS
* Investment companies sell shares to the public and use the
proceeds to invest in a portfolio of securities.
- Investment companies are generally nontaxable entities.
- Interest income, dividends, and capital gains all flow through
from the investment company to the shareholders.
INVESTMENT COMPANY TAX TREATMENT
INVESTMENT COMPANY TAX TREATMEN
Investment Companies avoid taxation by becoming registered investment
companies (RIC) through Internal Revenue Code Section 851.
* At least 90% of its income is from investments in stocks, bonds,
currencies, or other securities.
- At least 90% of the investment company’s taxable income must be
distributed to its shareholders. - For 50% of the portfolio, an investment in securities of any one issuer may not be greater than 5% of the total assets of the taxpayer, and no more than 10% of the outstanding voting securities of such issuer.
- No more than 25% of the value of a fund can be invested in the
securities of one issuer (other than government securities)
UNIT INVESTMENT TRUSTS
UNIT INVESTMENT TRUSTS
- A registered investment company that is passively managed
- UITs may invest in stocks, bonds or other securities.
- Investors purchase units, at net asset value plus commission, with
the intent of holding the units until they mature. - Investors receive distributions of income and principal from the trust, until all of the principal is returned to the investor
EXCHANGE TRADED FUNDS (EFTs)
EXCHANGE TRADED FUNDS (EFTs)
- Portfolios or baskets of securities that are traded on an exchange
- ETFs are index-based equity instruments.
- ETFs are usually passively managed.
- ETFs give investors the opportunity to buy and sell shares of an
entire stock portfolio as a single security.
CLOSED-END COMPANIES
CLOSED-END COMPANIES
- Closed-end shares trade in the same manner that publicly traded
stocks trade in the secondary market. - Prices are determined by supply and demand.
- Share prices tend to trade at a discount or a premium relative to
NAV.
OPEN-END COMPANIES
OPEN-END COMPANIES
- Open-end investment companies (mutual funds) are not limited in
the number of shares that can be sold. - The total capitalization of these funds is constantly changing.
- All shares are sold and redeemed by the mutual fund family.
MUTUTAL FUND FEES AND COSTS
MUTUTAL FUND FEES AND COSTS
All mutual funds have annual operating expenses, and many also
have one or more sales-related charges.
- No-load
- Front-end load
- Back-end load
12B-1 FEES
12B-1 FEES
- 12b-1 Fees: Pays for marketing and distribution expenses directly
from a fund’s asset base. - The maximum 12b-1 fee that can be charged for that purpose is 75
basis points (0.75%) per year. - Another 25 basis points can be charged as a “shareholder service
fee,” which effectively raises the annual potential 12b-1 to 1% of
assets per year.
OTHER MUTUAL FUND FEES (1 OF 2)
OTHER MUTUAL FUND FEES
- The management fee is charged by the investment adviser for the
management of the fund assets. - The expense ratio is disclosed in the fund prospectus. The expense
ratio is stated as a percentage of total assets. - Transaction costs include brokerage costs, spread costs, and
market-impact costs, and can range from 1% - 2% per year and are
not included in the expense ratio. - Brokerage costs result from the buying and selling of securities
within the mutual fund. - The bid-ask spread is the difference between the price that an
investor must pay (the ask price) to buy the security and the price
the investor will receive (the bid price) if they sell their shares. - Market-impact costs result from a market change in a security due
to a large trade
COMMISSIONS AND SOFT DOLLAR ARRANGEMENTS
COMMISSIONS AND SOFT DOLLAR ARRANGEMENTS
- Portfolio managers can buy/sell securities through a broker using
‘execution only’ style order. - Portfolio managers can also pay for extra services from the broker,
such as market research on specific securities, industries, or
economies. If those services are included in the commission fee,
they are known as soft dollars.
LOAD VS. NO-LOAD MUTUAL FUND
LOAD VS. NO-LOAD MUTUAL FUND
- Mutual funds without a front-end or a back-end load that have a
12b-1 fee that exceeds 25 basis points are also considered load
funds. - The 12b-1 fee must be 25 basis points or less to be called a no-load
fund. - Generally, no-load funds are purchased directly through the mutual
fund family without the assistance of a broker.
MUTUAL FUND CLASSIFICATION
MUTUAL FUND CLASSIFICATION
- Class A shares – These shares charge a front-end load with a
smaller 12b-1 fee. - Class B shares – These shares charge a deferred redemption fee
plus the maximum 1% 12b-1 fee. - Class C shares – These shares often have a level deferred sales
charge (often 1%), plus the maximum 12b-1 fee. - Class I shares – Institutional shares
SHARE CLASS SUMMARY
SHARE CLASS SUMMARY
ACTIVE VS. PASSIVE MANAGEMENT
ACTIVE VS. PASSIVE MANAGEMENT
- Actively managed funds require more research and support than
passively managed index funds. - Active management has higher expense ratios than passively
managed funds. - It is common for international equity funds to have higher expense
ratios than domestic equity funds due to more costly research
ADVANTAGES OF MUTUAL FUNDS
ADVANTAGES OF MUTUAL FUNDS
- Low initial investment amounts
- Diversification
- Ease of access
- Professional management
- Tax efficiency of management fees
- Liquidity
- Transaction cost efficiency
- Variety of mutual funds
- Services
DISADVANTAGES OF MUTUAL FUNDS
DISADVANTAGES OF MUTUAL FUNDS
- Performance
- Fees, Loads, and Expenses
- No Insurance
- Market Impact
- Classification System
- Built-in Gains
TYPES AND OBJECTIVES OF MUTUAL FUNDS
There are four main types of mutual fund categories:
TYPES AND OBJECTIVES OF MUTUAL FUNDS
There are four main types of mutual fund categories:
- Money market funds (15%)
- Fixed-income funds (22%)
- Equity funds (55%)
- Hybrid funds (8%)
MONEY MARKET MUTUAL FUNDS
MONEY MARKET MUTUAL FUNDS
Money market mutual funds provide investors the opportunity to earn competitive money market returns with the added benefits of ease of access and liquidity. Money market instruments include securities such as:
- Treasury bills
- Commercial paper
- Negotiable certificates of deposit
- Repurchase agreements
- Short-term municipal debt
FIXED-INCOME FUNDS
FIXED-INCOME FUNDS
- Fixed-income, or bond, mutual funds invest primarily in fixed-income securities ranging in maturity from several months to thirty years or longer.
- Fixed-income mutual funds were created to help investors manage
risks. - The most significant risk associated with bond mutual funds is
interest rate risk.
EQUITY MUTUAL FUNDS
EQUITY MUTUAL FUNDS
- Invest primarily in equity securities and have a variety of objectives.
- Some types of equity funds:
- Growth
- Value
- Sector
- World
- Hybrid
Closed-end fund shares most commonly sell: ???
At the fund’s net asset value.
At a premium to the fund’s net asset value.
At a discount to the fund’s net asset value.
At a price-to-earnings ratio between 15 and 16 times.
Confidence of your answer
At a discount to the fund’s net asset value.
Rationale
Although closed-end funds can trade at either a premium or a discount, they are most likely to trade at a discount. There are several reasons why this occurs, and many researchers cite supply and demand conditions, market sentiment, or liquidity issues. Perhaps the best answer is that closed-end funds typically use leverage that open-end funds cannot, and the extra risk is reflected in the discount.
The Stride Fixed Income Fund has year end market value of assets of EUR 650 million with EUR 30 million in market value of its liabilities. Stride reports a net asset value of EUR 45.25. The number of outstanding shares is closest to:
13,701,657.
Rationale
Market Value of Assets - Market Value of Liabilities NAV = --------------------------------------------------------------------------
Total Outstanding Shares
650 mill - 30 mill 45.25 = -----------------------------------
x
x = 13,701,657
Delta Mutual Funds had year-end assets of $625 million and liabilities of $35 million. There were 25 million shares in the fund at year-end. What was Delta Mutual Funds net asset value?
$23.60.
Rationale
Market Value of Assets - Market Value of Liabilities NAV = --------------------------------------------------------------------------
Total Outstanding Shares
($625 million - $35 million) ÷ $25.0 million = $23.60.
The Hound Dog Growth Mutual Fund is a highly sought after investment that owns $50 million in marketable securities, has $10 million worth of liabilities, and has 2 million outstanding shares. At what price should the fund’s shares trade?
A premium above $20.00.
$20.00.
$25.00.
It depends on the supply and demand for the shares; however, it should be close to if not exactly $20.00
$20.00.
Rationale
NAV = $20 per share ($50 million – $10 million)÷2m shares.
Market Value of Assets - Market Value of Liabilities NAV = --------------------------------------------------------------------------
Total Outstanding Shares
Mutual fund shares are always bought and sold at NAV.
An open-end mutual fund is most likely owned by:
The shareholders in the fund.
A family of funds mutual fund company.
The investment advisory firm.
The investment company
The shareholders in the fund.
Rationale
Mutual funds are owned by the owners of the fund who are known as the shareholders.
Which of the following is most likely characterized as a low-risk hybrid fund?
Invests in investment grade bonds and large company equities with brand name product lines.
Invests in combination of money market securities and shorter term bonds.
Invests in equity securities that have low levels of systematic risk.
Invests in bonds with low interest rate risk and low default risk.
invests in investment grade bonds and large company equities with brand name product lines.
Rationale
Hybrid funds combine debt and equity securities.
Low risk hybrid funds would invest in highly rated bonds and companies that are well known.
Which of the following is NOT one of the advantages of owning exchange-traded funds in a well-diversified portfolio?
They offer ease of trading similar to stocks.
They may be shorted; therefore, investors may speculate on a downturn.
Arbitrage pricing mechanisms do not apply, so exchange-traded funds have more stable pricing and are less volatile
Pricing is real time and is available throughout the day
Arbitrage pricing mechanisms do not apply, so exchange-traded funds have more stable pricing and are less volatile.
Rationale
ETFs are quite volatile.
In addition, the price for ETFs is kept in check through arbitrage.
arbitrage ?
The simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.
Rank the four types from highest to lowest in terms of invested assets:
Mutual funds, ETFs, closed-end funds, UITs.
Rationale
The largest amount of invested assets is in mutual funds, followed by ETFs and then closed-end funds. UITs have the least amount of invested assets.
Open-end funds and closed-end funds are similar except for:
Capitalization.
Objectives.
Regulation.
Investment management.
Capitalization.
Rationale
The funds are very similar except for capitalization. Open-end funds have a capitalization that changes constantly. Closed-end funds capitalization is fixed.
Which of the following investment companies is most likely characterized by continual ability to redeem shares?
Closed-end fund.
Open-end fund.
Unit investment trust.
Exchange trade fund
Open-end fund.
Rationale
Open end mutual fund managers will accept contributions and make redemptions on a daily basis for its investors.
Bianca, age 68, is retired and is concerned about preserving the value of her portfolio. Her secondary goal is to generate income. She has a portfolio of $500,000. Which of the following portfolio allocations would you recommend for her?
50% balanced fund, 15% short-term bond fund, 20% international equity, 15% S&P 500 index fund
40% S&P 500 index fund, 50% bond fund, 10% money market fund
30% S&P 500 index fund, 30% growth fund, 30% high duration bond fund, 10% money market fund
20% bond fund, 20% market neutral fund, 20% small-cap fund, 20% S&P 500 index fund, 20% growth and income fund.
40% S&P 500 index fund, 50% bond fund, 10% money market fund
Rationale
Option a is too risky with 20% international. Option c is too risky with 60% equity and a high duration bond fund. Option d is too risky with nearly 80% in equity type securities.
Thunder Equity Fund invests solely in the top one-half in size of firms in the oil and gas industry. Thunder is most likely characterized as a(n):
Growth fund.
Large cap fund.
Sector fund.
Income fund.
Sector fund.
Rationale
Sector funds limit their investments to firms within one industry.
To operate as a regulated investment company and enjoy the related tax benefits, a mutual fund must annually distribute to its shareholders
half of its realized capital gains, and interest and dividend income. none of its realized capital gains, but all of its interest and dividend income. all of its realized capital gains, and at least 90% of its interest and dividend income. all of its realized capital gains and interest and dividend income.
all of its realized capital gains, and at least 90% of its interest and dividend income.
