Professional Documents
Culture Documents
McGraw-Hill/Irwin
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c. Professional management Lower research costs Portfolio managed according to specific objectives Professionals to find undervalued securities
and/or engage in asset allocation strategies
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Organizational Forms
Unit Investment Trusts (UITs): unmanaged, fixed composition portfolios
Any interest and/or dividends are distributed immediately to trust certificate holders.
Provide diversification within one sector or area and low cost entry. Often levered, rates of return can be extreme.
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Organizational Forms
Managed Investment Companies: Managed, usually changing composition portfolio. ___________________________________ More commonly known as a mutual fund The fund's board of directors typically hires an investment advisor to select and manage the fund assets according to some specific goal(s) set by the board and any regulatory requirements.
The investment advisor usually creates the fund and selects the investments. Most funds are of this type.
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Organizational Forms
A managed investment company (mutual fund) may be
Open end shares are bought from the fund and redeemed by the fund or Closed end shares are bought and sold among investors in the marketplace (NASDAQ or an exchange) and the fund itself is not involved.
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Liquidity for the investor Funds ability to grow (advantage for the fund or
sponsor)
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REITs
Similar to closed end fund. Invest in real estate and real estate loans.
Equity trusts purchase real estate. Mortgage trusts invest in mortgage and construction loans.
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Hedge Funds
Similar to mutual funds, but not registered and not subject to SEC regulations. Available to institutional and high net worth investors Can pursue investment strategies that are not Grew from about $50 billion in 1990 to about $2 allowed for mutual funds. trillion in 2008.
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Calculation
Market Value of Fund Assets Fund Liabilitie s NAV Fund shares outstandin g
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Pricing
Open-end: Fund share price = Net Asset Value (NAV) Closed-end: Fund share price may trade at a premium or discount to NAV
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NAV calculation
ABC Fund ($Millions except NAV) Market Value Securities + Cash & Receivables - Current Liabilities NAV Total # Fund Shares $550.00 75.00 (20.00) $605.00 20.00 $ 30.25
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NAV
Sales force distributed Recommended by a broker or planner Usually will have a front end load May be revenue sharing on sales force
distributed Potential conflict of interest
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b.Growth
i.
Small, Med, Large Blend Substantial potential for c. Growth & Income Small, Med, Large Value capital loss i. Compatible Investor Goals ii.
Long time horizon
d.Countercyclical
*i. Morningstar fund definitions
Bear Market
Investment characteristics
Convertibles
Near term (to 2014), Intermediate (2015-2029), b. Target Date Funds Long term (2030+) Investment characteristics i. Compatible Investor Goals Hold both stocks and bonds,
Intermediate to long time horizon Willing to face higher tax liability Some ability to handle losses allocations may vary over time Turnover varies Higher income, lower capital gains & lower potential for capital loss
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b. CorporateShort, Ultrashort,
i. Intermediate, Long High Yield, Multisector ii. Emerging Markets, World iii. Bank Loans iv.
Compatible Investor Goals c. Geographic region d. Emerging markets Longer time horizon Investor seeking diversification and/or higher returns Ability to remain in the markets & handle losses
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Focus on safety of principal and income Earn more than on bank accounts with little additional risk Compatible Investor Goals Short time horizon Add stability to a portfolio Potentially large opportunity losses & inflation risk
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4:00 PM cutoff Strict _____________ with late orders executed the following trading day
Potential Reforms
Fair value pricing ________________ with net asset values being adjusted for trading in open markets
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(redemption fee)
12 b-1 charges Marketing costs paid by the fundholders Alternative to a load, but assessed annually Maximum is 1% of assets
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Best alternative may depend on amount invested and expected holding period _______________________________________.
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In MF prospectus and annual reports the MF returns are net of operating expenses, 12b-1 fees and commissions, but the returns do not include loads.
* This example calculates expenses using ending NAV.
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Conclusions?
Time dependent
Dist = Distribution
All distributions are taxable, even if reinvested in the fund. Do not buy into a MF just before its distribution date (usually near the end of the year or quarter).
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The investor is taxed on capital gain and dividend distributions at the investors appropriate tax rate. Distribution requirements imply that portfolio turnover may affect an investors tax liability.
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Sample Problems
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Problem 1
NAV is $10.70 Front-end load is 6% Every dollar paid results in only ____ going $.94 toward purchase of shares.
Offer price =
NAV = 1 - load $10.70 = 1-.06 $11.38
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Problem 2
Offer price $12.30 Front-end load is 5% $.95 Every dollar paid results in only ____ going toward purchase of shares. NAV = offer price x (1- load) = $12.30 x 0.95 = $11.69
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Problem 3
NAV = (Market Value of Assets Liabilities) Shares Outstanding A. (200,000)x($35) = $ 7,000,000 Liabilities B. (300,000)x($40) = $12,000,000 $30,000 C. (400,000)x($20) = $ 8,000,000 D. (600,000)x($25) = $15,000,000 Shares Outstanding $42,000,000 4,000,000 $42,000,000 $30,000 = $10.49 = NAV 4,000,000
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Problem 4
Turnover rate = Value of stocks sold and replaced Market Value Assets
MVA = $42M
Value of stocks sold = (600,000x$25)= $15,000,000 or Value of stocks purchased = (200kx$50)+(200kx$25) = $15,000,000 Market Value Assets = $42,000,000 $15,000,000 = 0.357 $42,000,000 Average holding period? or 35.7%
Problem 5
a. The empirical research suggests that past performance is not highly predictive of future performance, especially for better performing funds. There may be some tendency for the fund to perform better than average next year, but it is unlikely that the fund will be in the top 10%. b. Evidence suggests that bad performance is more likely to persist. Probably related to high fund costs or high turnover rates. Excessive costs are detrimental to a funds returns.
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Problem 6
As an initial approximation, your return equals the return on the shares minus the total of the expense ratio and purchase costs: Return 12% 1.2% 4% = 6.8% But the precise return is less than this because the 4% load is paid up front, not at the end of the year. To purchase the shares, you would have had to invest: $20,000 / (1 0.04) = $20,833 The shares net increase in value (12% 1.2%) from $20,000 to: $20,000 (1.12 0.012) = $22,160 The rate of return is: ($22,160 $20,833) / $20,833 = 6.37%
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Problem 7
a. Sell after 4 years: Suppose you have $1000 to invest. The $940 initial investment in Class A shares is ____ net of the front-end load. After 4 years, your portfolio will be worth: $940 (1.10)4 = $1,376.25 Class B shares allow you to invest the full $1,000, but your investment performance net of 12b-1 fees will be only 9.5%, and you will pay a 1% back-end load fee if you sell after 4 years. Your redemption value after 4 years will be: $1,000 (1.095)4 x 0.99 = $1,423.28 Class B shares are the better choice if your horizon is 4 years.
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Problem 7 Cont.
b. Sell after 15 years: What is the breakeven time? With a 15-year horizon, the Class A shares will be worth: N $940 x (1.10)N = $1,000 x (1.095) $940 (1.10)15 = $3,926.61 [$1,000 / $940 ] = (1.10)N / (1.095)N 1.06383 back-end load in this case = [1.10 / 1.095]N For the Class B shares, there is no since the horizon is greater LN 1.06383 = LN [1.10 / 1.095]value than 5 years. Therefore, the N of the Class B shares will be: 1.06383 = N x LN [1.10 / 1.095] LN
0.061875 = N x 0.004556 $1,000 (1.095)15 = $3,901.32 N = 13.581 years At this longer horizon, Class A shares are the better choice. Why?
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Problem 8
Suppose that finishing in the top half of all portfolio managers is purely luck, and that the probability of doing so in any year is exactly 50%. Then the probability that any particular manager would finish in the top half of the sample five years in a row is 0.505 = 0.03125. We would then expect to find that [350 0.03125] 11 managers finish in the top half for each of the five consecutive years.
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Problem 9
Trading costs will reduce the portfolio return by (0.4%)x(0.50)= 0.2% Over many years of savings these costs can greatly reduce the value of your portfolio. Remember also that the high turnover rate can have tax consequences that further reduces your after-tax return.
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