Chapter 04 – Mutual Funds and Other Investment Companies
CHAPTER 04
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Chapter 04 – Mutual Funds and Other Investment Companies
MUTUAL FUNDS AND OTHER INVESTMENT COMPANIES
1. Mutual funds offer many benefits. Some of those benefits include: the ability to invest
with small amounts of money, diversification, professional management, low
2. Close-end funds trade on the open market and are thus subject to market pricing.
3. 12b-1 fees are annual fees charged by a mutual fund to pay for marketing and
distribution costs.
4. A unit investment trust is an unmanaged mutual fund. Its portfolio is fixed and does
5. Exchange-traded funds can be traded during the day, just as the stocks they represent.
They are most tax effective, in that they do not have as many distributions. They have
6. Hedge funds have much less regulation since they are part of private partnerships and
7. An open-end fund will have higher fees since they are actively marketing and
8. Asset allocation funds may dramatically vary the proportions allocated to each market
9.
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© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Chapter 04 – Mutual Funds and Other Investment Companies
a. A unit investment trust offers low costs and stable portfolios. Since they do not
b. Open-end mutual funds offer higher levels of service to investors. The investors do
c. Individual securities offer the most sophisticated investors ultimate flexibility.
10. Open-end funds must honor redemptions and receive deposits from investors. This
flow of money necessitates retaining cash. Close-end funds no longer take and
11. The offering price includes a 6% front-end load, or sales commission, meaning that
every dollar paid results in only $0.94 going toward the purchase of shares.
Therefore:
Chapter 04 – Mutual Funds and Other Investment Companies
000,000,4
000,30$000,000,42$
14. The value of stocks sold and replaced = $15,000,000.
Turnover rate =
Value of stocks sold or replaced
Value of assets
=
000,000,42$
000,000,15$
= 0.3571 = 35.71%
15.
a. NAV =
Market v alue of assets－Market value of liabilities
S h ares outstanding
=
$200,000,000 － $3,000,000
5,000,000
= $39.40
b. Premium (or discount) =
=
40.39$
40.39$36$
= –0.0863 = –8.63%
16. Given the NAV at the beginning and the end of the period, and the distributions
during the period, we can use the equation below to solve for the rate of return of the
Corporate Fund:
Δ( NAV)－ Distribution s
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Chapter 04 – Mutual Funds and Other Investment Companies
b. An investor holding the same portfolio as the fund manager would have earned
a rate of return based on the increase in the NAV of the portfolio:
Rate of return =
Δ( NAV) － Distribution s
S tart of year NAV
=
= 0.1333 =
13.33%
18. Assume a hypothetical investment of $100. The end value of the investment will be
equal to I × (1– front-end load) × (1 + r– true expense ratio)T
Loaded-Up
We add the 12b-1 fee to the operating expenses to obtain the true expense
ratio:Expense ratio + (12b-1 fee) = 1% + 0.75% = 1.75%
Economy fund
19.
a. NAV =
Market v alue of assets－Market value of liabilities
Shares outstanding
=
$450,000,000 －$10 ,000,000
44,000,000
= $10
b. Because 1 million shares are redeemed at NAV = $10, the value of the portfolio
decreases to:
Portfolio value = $450million –($10×1million) = $440million
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Δ( Price) － Distribution s
Chapter 04 – Mutual Funds and Other Investment Companies
Market v alue of assets－Market value of liabilities
4 3 ,000,000
20.
a. Empirical research indicates that past performance of mutual funds is not highly
b. On the other hand, the evidence is more suggestive of a tendency for poor
performance to persist. This tendency is probably related to fund costs and
21. Start of year NAV =
Market v alue of assets－Market value of liabilities
Shares outstanding
=
$200,000,000
10,000,000
= $20
End of year NAV is based on the 8% price gain, less the 1% 12b-1 fee:
End of year NAV = $201.08(1 – 0.01) = $21.384
Given the dividends per share is $0.20, we can calculate the rate of return using the
following equation:
Rate of return =
Δ(NAV) － Distribution s
S tart of year NAV
=
 
20$
20.0$20$384.21$
= 0.0792 = 7.92%
22. The excess of purchases over sales must be due to new inflows into the fund.
Therefore, $400 million of stock previously held by the fund was replaced by new
holdings. So turnover is:
Turnover rate =
Value of stocks sold or replaced
Value of assets
=
$400,000,000
$2,200,000,000
= 0.1818 = 18.18%
23. Fees paid to investment managers were: 0.7%× $2.2 billion = $15.4 million.
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Shares outstanding
Chapter 04 – Mutual Funds and Other Investment Companies
24. Because the 4% load was paid up front and reduced the actual amount invested, only
96% (1.00 – .04) of the contribution was invested. Given the value of the portfolio
increased by 12% and the expense ratio was 1.2%, we can calculate the end value of
the investment against the initial contribution:
1 + r = 0.96(1 +0.12 0.012) = 1.0637
25. Suppose you have $1000 to invest. The initial investment in Class A shares is $940
net of the front-end load. After 4 years, your portfolio will be worth:
$940 (1.10)4 = $1,376.25
Class B shares allow you to invest the full $1,000, but your investment performance net
of 12b-1 fees will be only 9.5%, and you will pay a 1% back-end load fee if you sell
after 4 years. Your portfolio value after 4 years will be:
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Chapter 04 – Mutual Funds and Other Investment Companies
26.
a. After two years, each dollar invested in a fund with a 4% load and a portfolio
return equal to r will grow to:$0.96 (1 + r – 0.005)2
Each dollar invested in the bank CD will grow to:$1 (1.06)2
If the mutual fund is to be the better investment, then the portfolio return, r,
must satisfy:
b. If you invest for six years, then the portfolio return must satisfy:
0.96 (1 + r – 0.005)6> (1.06)6 = 1.4185
(1 + r – 0.005)6> 1.4776
c. With a 12b-1 fee instead of a front-end load, the portfolio must earn a rate of
return (r) that satisfies:
27. The turnover rate is 50%. This means that, on average, 50% of the portfolio is sold
and replaced with other securities each year. Trading costs on the sell orders are
0.4%; the buy orders to replace those securities entail another 0.4% in trading costs.
Total trading costs will reduce portfolio returns by: 2 0.004 0.50 = 0.004 or 0.4%
28. For the bond fund, the fraction of portfolio income given up to fees is:
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
Chapter 04 – Mutual Funds and Other Investment Companies
29. Suppose that finishing in the top half of all portfolio managers is purely luck, and that
the probability of doing so in any year is exactly ½. Then the probability that any
particular manager would finish in the top half of the sample five years in a row is
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.