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24
Chapter Objectives
Explain the concept of mutual fund operation Explain various types of mutual funds Describe the various types of stock and bond mutual funds Describe the characteristics of money market funds
Like depository institutions, mutual funds repackage proceeds from individuals to make investments Bank deposits are a liability contract, but a mutual fund represents partial ownership No federal insurance with mutual fund shares
Mutual fund itself is exempt from income taxation if fund distributes 90 percent of taxable income
Copyright 2002 Thomson Publishing. All rights reserved.
Check
Determine
fund Any interest or dividends added in Expenses subtracted Divide by the number of shares Dividends lower NAV NAV quotes
Copyright 2002 Thomson Publishing. All rights reserved.
Mutual fund classifications depend on the type of securities the fund invests in and can include
Stock or equity mutual funds Bond mutual funds Money market mutual funds
Money Market Funds $1,845 billion 27% Stock Funds $3,962 billion 57%
Expenses
Fees include management plus record-keeping and clerical fees Expense ratio = annual expenses/fund NAV Passed on to investors since NAV is reduced by fees Investor should compare expense ratios
Promoted by registered representatives of brokerage firms who get a commission Investors pay the sales charge 12b-1 expenses are loads used by no-load funds
Closed-end funds
Mutual fund does not repurchase the shares they sell similar to direct common stock investment Investors must sell shares on an exchange Number of outstanding shares is constant Value of shares related to expectations of portfolio and determined in market Willing to repurchase investor shares at any time Number of shares outstanding does not remain constant NAV determined by fund daily
Copyright 2002 Thomson Publishing. All rights reserved.
Types of Loads
Front end load is paid only once, at the time you invest money in a mutual fund. Back end load is a withdrawal fee assessed when you withdraw money from mutual fund.
12b-1 Fees, a distribution fee in reference to SEC rule 12b-1. Funds have used the proceeds from 12b-1 fees to pay commissions to brokers whose clients invested in fund.
Copyright 2002 Thomson Publishing. All rights reserved.
Growth funds for investors who want high returns with moderate risk
Mutual fund invests in companies that are expected to grow at a higher than average rate Generate an increase in investment value rather than steady income
Returns affected by stock prices Returns also affected by foreign exchange rates
Bond Funds
6000
Stock Funds
5000
4000
3000
2000
1000
Year
Stock Funds
3000
2000
1000
0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
Tax implications of bond fund investments Income bond funds vary in terms their exposure to credit risk and focus on periodic coupon payments and attract investors who are
Interested in periodic income since prices are volatile Plan to hold the fund long term
International bond funds contain bonds issued by governments or corporations from other countries Global funds may contain both U.S. and foreign bonds
Maturity classifications
Interest rate sensitivity depends on the maturity of bonds Funds are typically segmented based on maturity
Intermediate-term
funds invest in bonds with 5 to 10 years remaining to maturity Long-term funds invest in maturities of 15 to 30 years
Both investors and managers closely monitor performance as modeled by the equation below
Close relationship between performance and market conditions Depends on the focus of the fund
Index
Change in management ability includes both managers skills and operating efficiency
Copyright 2002 Thomson Publishing. All rights reserved.
Performance
is affected by changes in the premium or discount relative to NAV If the funds premium increases relative to NAV, return to fund holders increases
Performance of bond mutual funds as shown in the model below PERF= f ( Rf, RP, CLASS, MANAB)
PERF = Performance Rf = Risk free interest rates RP =Risk premium CLASS =the classification of the bond fund MANAB = The ability of the bond funds management
Copyright 2002 Thomson Publishing. All rights reserved.
Where:
Risk
premiums increase in recessions Risk premiums decrease in boom times as investors buy riskier investments
Copyright 2002 Thomson Publishing. All rights reserved.
Change in management abilities Performance of closed-end bond funds is affected by all of the other factors and changes in the premium or discount
Using return only is not valid Mutual funds typically do not outperform the market Evaluate mutual fund expenses
Consistent
positive returns over time Lower credit risk Lower interest rate risk
Copyright 2002 Thomson Publishing. All rights reserved.
Funds are exempt from tax if 90% of earnings are distributed to shareholders
Hedge Funds
Sometimes seen as an inflation hedge Performance influenced by interest rates and area real estate performance
Other Issues
Mutual funds interact with banks, savings institutions, finance companies, securities firms, insurance companies, and pension funds Mutual funds typically use all the various financial markets including money, bond, mortgage, stock, futures, options, and swap markets Globalization is facilitated by mutual funds