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Chapter Nineteen

Chapter Nineteen. Mutual Funds. Learning Objectives. 1. Understand the concept of a mutual fund. 2. Distinguish between closed-end and open-end funds 3. Explain the difference between load and no-load funds. 4. Compute the net asset value of a fund.

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Chapter Nineteen

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  1. Chapter Nineteen Mutual Funds

  2. Learning Objectives 1. Understand the concept of a mutual fund. 2. Distinguish between closed-end and open-end funds 3. Explain the difference between load and no-load funds. 4. Compute the net asset value of a fund. 5. Identify the key information sources for mutual funds. 6. Explain how to evaluate the performance of a mutual fund.

  3. Percent of U.S. Households 60 50 40 30 20 10 0

  4. Advantages of Mutual Funds • Efficient way to diversify • The expertise of fund managers • Broad range of funds • Stock funds • Bonds: U.S. gov't. and corporate • Municipal securities

  5. Disadvantages of Mutual Funds • Mutual funds do not outperform the market in the long-run. • Some mutual funds can be expensive to purchase. • Buyer beware: Past performance does not guarantee future performance.

  6. Closed-end Funds • A closed end mutual fund has a fixed number of shares. • Purchasers and sellers of shares must trade with each other. • Shares are bought from the fund at inception only. • Fund does not stand ready to buy the shares back from investors.

  7. Closed-end Funds (Cont.) • Closed-end funds trade in securities markets at a discount or premium from Net Asset Value (NAV). • NAV = Total Value of Securities - Liabilities Shares Outstanding • Funds may trade at discount or premium, depending upon past performance.

  8. Index Traded Closed-End Funds • Essentially index-based mutual funds that imitate a market index such as S&P 500. • Fund numbers (Sept. 2001) • domestic funds = Sixty Six (66) • International funds = Twenty Six (26) • Advantage • Enables investor to "buy the market" • Disadvantage • Investor gets "market results"

  9. Open-End Funds • An open-end fund stands ready at all times to sell or buy back shares. • NAV= Total Value of Securities - Liabilities Shares Outstanding • NAV is computed at the end of each day for a fund. • Only factor that changes the NAV is the up and down movement of the securities in the funds portfolio

  10. Comparison of funds

  11. Load versus No-Load Funds • A load fund is a fund which charges a commission for the sale of its shares. • Commission may run as high as 7.25%. • NAV is usually less than offer price because the commission must be paid. • Low-load funds • Back-end load funds • No-load funds • Sold directly, thus no commission • Annual management fee of .75% - 1.25% of fund value ( similar to load fund management fees). • No-load funds performance equivalent to load-funds.

  12. Mutual Fund Information Sources • Wall Street Journal • NAV, Net change, Year-to-date % return • Barron's • Morningstar Mutual Fund Survey • Ranks funds on a One-star to Five-star rating system

  13. Differing Objectives and the Diversity of Mutual Funds • Money Market Funds • short-term securities (t-bills, CDs, etc.) • Growth Funds • emphasis capital appreciation • Growth with Income • steady dividends with growth potential • Balanced Funds • Combine common stock, bonds, and may include preferred stock.

  14. Differing Objectives and the Diversity of Mutual Funds • Index funds • replicate a market index • Bond Funds • corporate, U.S. govt., municipals • junk bond funds • Sector Funds • Foreign Funds • Specialty Funds • Hedge Funds

  15. Investment Objective and Fund Types • Goal: Safety of principal and steady income • Money market funds • intermediate term bond funds • Goal: licquidity • all funds • Goal: Capital appreciation • aggressive growth funds • Goal: Growth and income • growth-income and balanced funds

  16. The Prospectus • Information deemed essential by SEC in providing "full disclosure" • Investment Objectives and Policies • Portfolio (or “Investment Holdings”) • Management Fees and Expenses • Turnover Rate

  17. Distribution and Taxation • Distributions • Capital gains distributed annually • Income distributed quarterly or annually • Fund not subject to Federal Income taxes if 90% or more of gains are distributed • Sale of mutual fund shares subject to normal securities sales income tax liabilities.

  18. Shareholder Services • Automatic Reinvestment • Safekeeping • Exchange Privilege • Pre-authorized check plan • Systematic withdrawal plan • Checking privileges

  19. Table 19-7. Dollar-Cost Averaging

  20. Computing Total Return Assume the following: 14.05= Beginning NAV 15.10= Ending NAV 1.05= Change in NAV (+) 0.40= Dividends distributed 0.32= Capital Gains distributed $ 1.77= Total Return Total Return $ 1.77 Beginning NAV $14.05 = = 12.60%

  21. Evaluating Fund Performance • Sources of information • Forbes ratings • Morningstar ratings • American Association of Individual Investors • Lipper Mutual Fund Performance

  22. Potential Sources of Return • Change in NAV • Macro-economic effects of market movements • Dividends • Dividends collected by the fund on stocks in the fund and distributed to shareholders • Capital gains • Gains from trading operations of the funds

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