CHAPTER 17: INVESTMENT COMPANIES
THEORY QUESTIONS TO PREPARE
Question 1
What is a mutual fund? In what sense is it a financial institution?
Answer
A mutual fund is a financial institution that pools money from individuals
and companies and invests those funds in portfolios of assets such as
stocks, bonds, and money market securities.
It is considered a financial institution because it:
collects funds from savers,
invests those funds,
manages portfolios,
and acts as an intermediary between investors and financial
markets.
Question 2
What benefits do mutual funds have for individual investors?
Answer
Benefits include:
diversification,
professional management,
liquidity,
lower investment costs,
convenience,
and easier access to financial markets.
Open-end funds also allow investors to redeem shares daily at NAV.
Question 3
What are long-term mutual funds? In what assets do these funds
usually invest?
Answer
Long-term mutual funds invest in securities with maturities greater than
one year.
They usually invest in:
common stock,
preferred stock,
bonds,
hybrid securities.
Types:
Equity funds
Bond funds
Hybrid funds
Question 4
What are money market mutual funds? In what assets do these
funds typically invest?
Answer
Money market mutual funds (MMMFs) are mutual funds that invest in
short-term money market securities with maturities less than one year.
They typically invest in:
Treasury bills,
commercial paper,
certificates of deposit,
other short-term securities.
Question 5
What is the difference between an open-end mutual fund and a
closed-end fund?
Answer
Open-End Fund Closed-End Fund
Continuously issues shares Fixed number of shares
Redeemable through fund Traded in market
Market price may differ from
Price based on NAV
NAV
Open-End Fund Closed-End Fund
Includes mutual funds and
Shares traded after IPO
ETFs
Closed-end funds can trade above or below NAV.
Question 6
What is the difference between a load fund and a no-load fund?
Answer
Load Fund
Charges an upfront sales commission or fee.
No-Load Fund
Does not charge upfront commission fees.
Question 7
What are the three components of return from mutual fund
ownership?
Answer
Investor returns from mutual funds come from:
1. Income and dividends
2. Capital gains
3. Capital appreciation
Question 8
What is NAV? What is meant by marked-to-market daily?
Answer
NAV
Net Asset Value is the value of one mutual fund share.
Formula:
Assets−Liabilities
NAV =
Shares Outstanding
Marked-to-Market Daily
This means mutual fund assets are revalued daily using current market
prices.
Managers:
1. Calculate total market value of assets,
2. Subtract liabilities,
3. Divide by shares outstanding.
Question 9
What are the major hedge fund strategies?
Answer
Major hedge fund strategies include:
short selling,
leverage,
arbitrage,
program trading,
derivatives.
Hedge funds use aggressive trading strategies and generally take higher
risks than mutual funds.
Question 10
What are the categories of hedge funds?
Answer
Market Directional (More Risky)
High returns using leverage
Invest based on anticipated events
Market Neutral / Value Orientation (Moderate Risk)
Moderate market exposure
Longer-term strategies
Market Neutral (Risk Avoidance)
Moderate and consistent low-risk returns
NUMERICAL QUESTIONS TO PREPARE
Numerical 1: Closed-End Fund Identification
Question
A fund has a NAV of $30 per share but is selling for $32. What type of fund
is this?
Solution
Since the market price differs from NAV:
32 ≠30
it must be a closed-end fund because closed-end funds trade in markets
and prices may differ from NAV.
Final Answer
Closed-end fund
Numerical 2: NAV Calculation
Question
A mutual fund owns:
1,500 shares at $12
1,000 shares at $43
2,000 shares at $50
The fund has 3,500 shares outstanding.
Find NAV.
Formula
Total Asset Value
NAV =
Shares Outstanding
Step 1: Total Asset Value
¿¿ 18,000+ 43,000+100,000¿ 161,000Step 2: Divide by Shares Outstanding
161,000
¿ 46 Final Answer
3,500
NAV =$ 46 Numerical 3: Number of Fund Shares
Question
You invest $17,445 in a mutual fund.
NAV = $26.03
Front-end load = 4.5%
Find number of shares received.
Formula
Investment ×(1−Load)
¿ of Shares=
NAV
Step 1: Deduct Load
17,445 ×(1−0.045)¿ 17,445 ×0.955¿ 16,659.975Step 2: Divide by NAV
16,659.975
≈ 640Final Answer
26.03
640 shares
Numerical 4: Mutual Fund Return Calculation
Question
An investor invests $10,000 in a mutual fund.
Load fee = 6%
Expense ratio = 1.35%
Gross return = 11.5%
Find first-year net return.
Step 1: Initial Investment After Load
10,000−(0.06 × 10,000)¿ 9,400 Step 2: Amount After Gross Return
9,400 ×1.115¿ 10,481Step 3: Average Assets
9,400+10,481
¿ 9,940.50 Step 4: Fees
2
9,940.50 × 0.0135¿ 134.20Step 5: Ending Amount After Fees
10,481−134.20¿ 10,346.80Step 6: Net Return
10,346.80
−1¿ 3.47 % Final Answer
10,000
Net Return=3.47 %