Chapter 04 – Mutual Funds and Other Investment Companies
CHAPTER 04
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
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 not
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
free from most SEC regulation. They permit investors to take on many risks
7. An open-end fund will have higher fees since they are actively marketing and managing
8. Asset allocation funds may dramatically vary the proportions allocated to each market
in accord with the portfolio manager’s forecast of the relative performance of each
9.
a. A unit investment trust offers low costs and stable portfolios. Since they do not
change their portfolios, investors know exactly what they own. They are better suited to
sophisticated investors.
10. Open-end funds must honor redemptions and receive deposits from investors. This flow
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:
13. Given that net asset value equals assets minus liabilities expressed on a per-share basis,
we first add up the value of the shares to get the market value of the portfolio:
Stock
Value Held by
Fund
A
$ 7,000,000
B
12,000,000
C
D
15,000,000
14. The value of stocks sold and replaced = $15,000,000.
Turnover rate = Value of stocks sold or replaced
Value of assets
Chapter 04 – Mutual Funds and Other Investment Companies
15.
a. NAV = Market value of assets － Market value of liabilities
Shares outstanding
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:
17. As the price of a close-end fund may deviate from its NAV, we instead use the price of
the net asset value when we calculate the rate of return:
a. Start of year price = $12.00 1.02 = $12.24
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:
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
Chapter 04 – Mutual Funds and Other Investment Companies
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%
a. Year 1 = $100 (1 + 0.06 – 0.0175) = $104.25
Economy fund
a. Year 1 = $100 0.98 (1 + 0.06 – 0.0025) = $103.64
19.
a. NAV = Market value of assets － Market value of liabilities
Shares outstanding
b. Because 1 million shares are redeemed at NAV = $10, the value of the portfolio
decreases to:
Portfolio value = $450million – ($10 × 1million) = $440million
20. a. Empirical research indicates that past performance of mutual funds is not highly
predictive of future performance, especially for better-performing funds. While
there may be some tendency for the fund to be an above average performer next
21. a. Start of year NAV = Market value of assets － Market value of liabilities
Shares outstanding
Given the dividends per share is $0.20, we can calculate the rate of return using the
following equation: b. Rate of return = Δ(NAV) ＋ Distributions
Start of year NAV
Therefore, $400 million of stock previously held by the fund was replaced by new
holdings. So turnover is:
23. a. Fees paid to investment managers were: 0.7% × $2.2 billion = $15.4 million.
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
Chapter 04 – Mutual Funds and Other Investment Companies
25.
a.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
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:
0.96 (1 + r – 0.005)2 > (1.06)2
b. If you invest for six years, then the portfolio return must satisfy:
Chapter 04 – Mutual Funds and Other Investment Companies
c.
c-1. 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
28.
a. For the bond fund, the fraction of portfolio income given up to fees is:
b. For the equity fund, the fraction of investment earnings given up to fees is:
c. Fees are a much higher fraction of expected earnings for the bond fund, and
therefore may be a more important factor in selecting the bond fund.
This may help to explain why unmanaged unit investment trusts are
29. Equity funds and fixed-income funds contain different types of securities. Therefore,
there are numerous differences that make comparison difficult. Equity funds invest
30. 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