Behavioral Finance

Behavioral Finance Economics 437

Historic Forms of Mutual Funds • Open End Funds • Closed End Funds

Open End Funds are the Typical • An investors sends cash to the mutual fund to buy a unit interest in the fund • The fund takes the investor’s cash and buys securities in exactly the same proportions as exist in the current fund • When an investor sells his unit interest, the fund liquidates shares in the funds to redeem the investor’s interest

Closed End Funds • They begin by purchasing securities • Then they do an IPO to the public selling shares in the fund • After that, the fund shares are fixed in number and the shares trade in the open market

Problem • No problem with open end fund. The investor buys and sells at NAV (net asset value) • Problem arises with closed end fund • Price of a share can diverge from the stock values in the fund • Begin at a premium and, over time, trade at a discount • Discount only goes away when fund is terminated

ETFs (Exchange Traded Funds) • Created much like closed end funds: securities pooled together to create a fund • Then shares in the pool sold to the public • But (“creation units”) • Shares can be created • Shares can be destroyed • Permits arbitrage to solve the closed end puzzle

The End

Behavioral Finance