Slides_Fundamentals of Investments - Chapter 4 doc

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C h a p t e r
Mutual FundsMutual Funds
second edition
Fundamentals
of
Investments
Valuation & Management
Charles J. Corrado Bradford D.Jordan
McGraw Hill / Irwin Slides by Yee-Tien

(Ted) Fu
© 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw Hill / Irwin
4 - 2
Mutual Funds
Our goal in this chapter is to
understand the different types of
mutual funds, their risks, and returns.
Goal
 Investors added $363 billion in net new funds
to mutual funds in 1999, and by the end of the
year, mutual fund assets totaled $6.85 trillion.
These were estimated to be owned by
83 million Americans.
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Mutual Funds
 Mutual funds are simply a means of combining

or pooling the funds of a large group of
investors.
 The buy and sell decisions for the resulting
pool are then made by a fund manager, who is
compensated for the service provided.
 Like commercial banks and life insurance
companies, mutual funds are a form of
financial intermediary.
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Investment Companies and Fund Types
Investment company
A business that specializes in pooling funds
from individual investors and investing them.
Closed-end fund
An investment company with a fixed
number of shares that are bought and sold
only in the open stock market.
Open-end fund
An investment company that stands ready to
buy and sell shares at any time.
Investment Companies and Fund Types
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Hill Companies Inc.All rights reserved.
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© 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Investment Companies and Fund Types
 Shares in an open-end fund are worth their
NAV, because the fund stands ready to redeem
their shares at any time.
 In contrast, the shares of closed-end funds may
or may not be equal to their NAV.
Net asset value
The value of the assets held by a mutual
fund, divided by the number of shares.
Abbreviated NAV.
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Work the Web
 For mutual fund facts and figures,
visit:

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Mutual Fund Operations
Organization and Creation
 A mutual fund is simply a corporation. It is
owned by shareholders, who elect a board of
directors.
 Most mutual funds are created by investment
advisory firms (such as Fidelity Investments),

or brokerage firms with investment advisory
operations (such as Merrill Lynch).
 These firms wish to manage the funds to earn
fees.
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Work the Web
 All the major fund families have
websites. Try, for example:

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Mutual Fund Operations
Taxation of Investment Companies
 An investment company that
c holds almost all its assets as investments in stocks,
bonds, and other securities,
d uses no more than 5% of its assets when acquiring
a particular security, and
e passes through all realized investment income to
fund shareholders,
is treated as a “regulated investment company”
for tax purposes and does not need to pay taxes
on its investment income.
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Mutual Fund Operations

The Fund Prospectus and Annual Report
 Mutual funds are required by law to supply a
prospectus to any investor who wishes to
purchase shares.
 Mutual funds must also provide an annual
report to their shareholders.
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Mutual Fund Costs and Fees
Types of Expenses and Fees
c Sales charges or “loads.” Front-end loads are
charges levied on purchases, while back-end
loads are charges levied on redemptions.
d 12b-1 fees. SEC Rule 12b-1 allows funds to
spend up to 1% of fund assets annually to
cover distribution and marketing costs.
e Management fees. Usually based on fund size,
performance, etc.
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Mutual Fund Costs and Fees
Types of Expenses and Fees …continued
f Trading costs. This is related to the fund’s
turnover.
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Mutual Fund Costs and Fees

Expense Reporting
 Mutual funds are required to report expenses
in a fairly standardized way in the prospectus.
c Shareholder transaction expenses - loads and
deferred sales charges.
d Fund operating expenses - management and 12b-1
fees, legal, accounting, and reporting costs,
director fees.
e Hypothetical example showing the total expense
you would pay over time per $10,000 invested.
Mutual Fund
Costs & Fees
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Work the Web
 Prospectuses are increasingly available
online. To see some examples, visit:

 To see a fund that really discloses
information, try:

Check out the “plain language” risk
disclosure!
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Mutual Fund Costs and Fees
Why Pay Loads and Fees?
 You may want a fund run by a particular
manager, and all such funds are load funds.
 You want a specialized type of fund. Loads
and fees for such funds tend to be higher as
there is little competition among them.
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Short-Term Funds
 Short-term funds are collectively known as
money market mutual funds, or MMMFs.
 MMMFs always maintain a $1 net asset value
to make them resemble bank accounts.
 Depending on the type of securities purchased,
MMMFs can be either taxable or tax-exempt.
Money market mutual fund
A mutual fund specializing in money market
instruments.
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Short-Term Funds
 Most banks offer what are called “money
market” deposit accounts, or MMDAs, which
are much like MMMFs.
 The distinction is that a bank money market
account is a bank deposit and offers FDIC

protection.
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Work the Web
 For information on thousands of
funds, including MMMFs, visit:

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Long-Term Funds
 A fund’s objective is the major determinant of
the fund type.
 Historically, mutual funds were classified as
stock, bond, or income funds. However, it is
becoming increasingly difficult to do so.
Stock, bond,
or income?
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Stock Funds
 Some stock funds trade off capital appreciation
and dividend income.
Î Capital appreciation, growth, growth and income,
equity income.
 Some stock funds focus on companies in a
particular size range.
Î Small company, midcap.

 Some fund groups invest internationally.
Î Global, international, region, country, emerging
markets.
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Stock Funds
 Sector funds specialize in specific sectors of
the economy.
 Other fund types include index funds, social
conscience funds, and tax-managed funds.
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Bond Funds
 Bond funds may be distinguished by their
c maturity range , d credit quality,
e taxability, f bond type, and g issuing
country.
 Bond fund types include short-term and
intermediate-term funds, general funds, high-
yield funds, mortgage funds, world funds,
insured funds, single-state municipal funds.
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Stock and Bond Funds
 Funds that do not invest exclusively in either
stocks or bonds are often called “blended” or
“hybrid” funds.

 Examples include balanced funds, asset
allocation funds, convertible funds, income
funds.