FIN3244 Exam 3 Study Guide 1 Mutual Fund Performance Sources of Return 15 11 2011 03 14 00 o An open end mutual fund as 3 potential sources of return A Dividend income Derived from the dividends and interest earned on the security holdings of a mutual fund Paid out of the net investment income that s left after the fund has met all operating expenses Paid out on a prorated basis B Capital gains distribution Derived from the capital gains actually earned by the fund Payment made to mutual fund shareholders that come from the profits that a fund makes from the sale of its securities C Change in the price or net asset value of the fund A capital gain made only on paper that is not realized until the fund s holdings are sold o For closed end investment companies Return is derived from the same 3 sources as above AND from a fourth source as well The 3rd element of return change in share price is made up of not only change in net asset value but also of change in price discount or premium Example of closed end funds Stock market NASDAQ over the counter markets o Open end mutual funds regularly publish reports that recap investment performance Found in fund s profile or prospectus and gives overview of fund s investment activity including expense ratios and portfolio turnover rates Future Performance o A mutual fund s future performance is directly linked to the future make up of the securities in its portfolio something that is almost impossible to know Mutual funds investment performance depends on the behavior of many different stocks and bonds o It is a good idea to try to get an idea of the general tone of the market o Also evaluate the track records of mutual funds past performance has a lot to say about the investment skills of the fund s money managers 2 Type of Mutual Funds A Growth Funds a mutual fund whose primary goals are capital gains and long term growth average growth o Invest in well established large or mid cap companies that have above o Offer little if any dividends and current income o Fair amount of risk exposure B Aggressive growth funds a highly speculative mutual fund that seeks large profits from capital gains among most volatile of all mutual funds o Most fairly small average assets less than 300 million o high flying common stocks o may use leverage buy stocks on margin o use options aggressively various hedging techniques and short selling o when markets are good these do well When markets are bad they experience substantial losses C Value Funds seeks stocks that are undervalued in the market by investing in shares that have low P E multiples high dividend yields and promising futures o This is not easy and takes extensive evaluation of financial statements and documents o Considered less risky than growth investing o Viable investment alternative for relatively conservative investors who want attractive returns but want to keep share price volatility and investment risk in check D Equity Income Funds emphasizes current income and capital preservation and invests primarily in high yielding common stocks 2 o High grade common stocks convertible securities and preferred stocks o Lean heavily toward blue chips public utilities and financial shares o Fairly low risk E Balanced Funds objective is to generate a balanced return of both current income and long term capital gain o Much like equity income funds but they put more into fixed income securities o 30 40 of income in bonds used to provide current income socks selected for their long term potential growth o high grade securities growth oriented blue chip stocks high quality income shares o safe form of investing not too risky F Growth and Income Funds seeks both a long term growth and current income with primary emphasis on capital gains o Unlike balanced funds they put most of their money into equities 80 90 of capital in common stocks o Quality issues blue chips high quality income stocks o Fair amount of risk G Bond Funds a mutual fund that invests in various kinds and grades of bonds with income as the primary objective o Treasury bonds agency bonds corporate bonds municipal bonds o Income is primary objective but capital gains are not ignored o There are 3 important advantages to buying shares in bond funds instead of directly investing in bonds i bond funds are more liquid than direct investment in bonds ii they offer a cost effective way of achieving a high degree of diversification in an otherwise expensive investment vehicle iii bond funds will automatically reinvest interest and other income allowing you to earn fully compounded rates of return o conservative form of investment but not without risk prices of bonds held in funds portfolio fluctuate with changing interests o Different types of domestic bond funds available to investors 3 i Government bond funds US treasury and agency securities ii Mortgage backed bond funds appealing because provide diversification affordable way to get into mortgage backed securities allow investors to reinvest principal portion of monthly cash flow enabling them to preserve capital iii high grade corporate bonds funds investment grade securities rated triple B or better iv High yield corporate bond funds risky investments that buy junk bonds v Convertible bonds funds offer price stability of bonds vi Municipal bond funds invest in tax exempt securities tax free Single state tax fund fully exempt from both federal and income state taxes vii Intermediate term bond funds bonds with maturities of 7 to 10 years or less Attractive yields and low price volatility H Money Market Funds pools the capital of investors and uses it to invest in short term money market instruments o Bank certificates of deposit US treasury bills ect o Offer investors modest amounts of capital access to the high yielding money market o Highly liquid investment vehicles Just as liquid as checking or savings account o Virtually immune to capital loss because 95 of assets must be invested in top rated prime grade securities o Convenient safe and reasonable profitable way to accumulate capital and temporarily store idle funds o Several kinds of money market mutual funds i general purpose money funds invest in all types of money market investment vehicles 4 treasury bills bank CDS corporate commercial paper majority of money funds ii government securities money funds eliminate risk of default by confining investment to Treasury bills and other securities of US gov or its agencies iii tax exempt
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