Week 2: Mutual Funds Industry

Question 1

what is the difference between price and performance indices?

Answer 1

Price index only considers stock price changes. Performance index considers stock price changes + dividend returns.

Question 2

Sharpe ratio formula:

Answer 2

S=(r-rf)/σ

r = return of asset
rf = risk-free rate
σ = asset’s volatility

Question 3

What are the 4 primary fund types?

Answer 3

1. Stock
2. Bond
3. Hybrid
4. Money Market Mutual Fund

Question 4

How do you calculate NAV?

Net Asset Value

Answer 4

(assets - liabilities)/#shares

assets = total value of fund’s securities
liabilities = fees, etc.

Question 5

5 benefits of Mutual Funds

Answer 5

1. Liquidity Intermediation
2. Denomination Intermediation
3. Diversification
4. Cost Advantages
5. Managerial Expertise

Question 6

What is the difference between open-ended and closed-end funds?

Answer 6

closed-ended:
* fixed number of non-reedemable shares
* Initial offering then OTC market
* price determined by supply & demand

open-ended:
* Can be bought/sold at any point
* Price determined by NAV (Net asset value)

Question 7

What is liquidity Intermediation?

Answer 7

Ability to easily convert investments into cash while fund is still groing

Question 8

What is denomination intermediation

Answer 8

Fund allows investors to make investments that require more capital than they possess

Question 9

3 types of Stock bonds:

Answer 9

1. Capital appreciation funds
2. Total return funds
3. World Equity Funds

Question 10

Investment Grade vs high yield bond funds

Answer 10

Investment grade: Good rating, low return
High yield: low rating, high return

Question 11

What are the benefits/drawbacks of money market funds? Give an example

Answer 11

Benefit: Higher return than bank deposits
Drawback: not federally insured
Example: repo agreements

Question 12

What are index funds (ETFs)?

Answer 12

Fund that contains the stock of an index

Question 13

What are index funds (ETFs)?

Answer 13

Fund that contains the stock of an index
Advantage: no fees because no manager

Question 14

Fee Structures of investment funds

Answer 14

Class A: Load Funds - upfront fee
Class B: Deferred-load - fee upon redemption of shares
Class C: no fees

Question 15

What are Hedge funds?

Answer 15

Type of investment tool that collects funds from individuals and invests them on their behalf.

They take advantage of unusual spreads between security prices

Question 16

Difference between Hedge funds & Mutual Funds

Answer 16

• Little regulation
• High Costs
• High Minimum investment
• Typically levered

Question 17

What are 2 issues in the mutual fund industry?

Answer 17

Asymmetric information
Principal-agent problem

Question 18

What are forms of mutual fund abuse?

Answer 18

Late trading - illegal
Market Timing - legal

Question 19

How can the government respond to mutual fund abuse?

Answer 19

• Hardening of late trading rule
• Redemtion fee enforcement
• Increased Transparency
• Require Independent directors

redemption fees: additional fees for short-term investments

Question 20

wAccording to the Gordon growth model, what is an investor’s valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor’s required return is 11 percent?

Answer 20

$110