HACE 3200 1nd Edition Lecture 26 Outline of Last Lecture I Bonds II Pass through certificates Outline of Current Lecture I Mutual Funds II Types of Investment Companies III Investment Trusts Current Lecture Chapter 15 Mutual Finds An easy way to Diversify o What is a mutual fund Investment Company that pools money from investors to buy stocks bonds and other investments Investors own a share of the fund proportionate to the amount of the investment Concepts o The money thus collected is then invested in capital market instruments such as stocks and other securities o The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them o Thus a Mutual Fund is a most suitable investment for the common man as it offers an opportunity to invest in a diversified professionally managed basket of securities at a relatively low cost Why invest in Mutual Funds o Benefit of the small investor diversification and reduced risk o Level the playing field between corporations and the individual investor Advantages of Mutual Fund Investing o Diversification owning numerous securities reduces risk o Professional management one hopes o Minimal transaction costs These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute o Liquidity o Flexibility o Service o Avoidance of bad brokers Disadvantages of Mutual Fund Investing o Lower than market performance 1989 1998 average annual returns Actively managed stock funds 15 6 S P 500 stock index 19 2 Costs Risks unsystematic risk Risk systematic risk Capital gains taxes Frequently used Terms o Net asset value Net asset value is the market value of the assets of the scheme minus its liabilities The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation date o Sale Price Is the price you pay when you invest in a scheme Also called Offer price It may include a sales load o Repurchase price Is the price at which a close ended scheme repurchases its units and it may include a back ended load This is also called Bid price o Redemption Price Is the price at which open ended schemes repurchase their unit and close ended schemes redeem their units on maturity Such prices are NAV related o Sales Load Is a change collected by a scheme when its sells the unit Also called front end load Schemes that do not charge a load are called No load schemes o Repurchase or Back end load Is a charge collected by a scheme when it buys back the units from the unit holders o To operate Mutual Funds Pool money from investors with similar goals Invest in numerous securities Hire a management company to run the fund 4 types of Investment Companies o open end investment companies or mutual funds o closed end investment companies o unit investment trusts o real estate investment trusts Open End Investment Companies o Have an unlimited number of shares o Buy and sell shares directly to investors without a secondary market o Purchase and selling price is determined by the net asset value of the fund Net Asset Value NAV o The dollar value of a share in a mutual fund NAV total market value of all securities liabilities total shares of outstanding Closed end investment companies o Have a limited number of shares o Sell only the initial offering Subsequent trades are done in a secondary market similar to the common stock market o Purchase and selling price is determined by supply and demand Unit Investment Trusts o Fixed pool of securities normally municipal bonds o Are passive investments that operate on a buy and hold strategy o Normally require 1 000 minimum investment o Long time horizon recommended Real Estate Investment Trusts o Have 3 types equity mortgage hybrid o Lack the liquidity of most mutual funds but more liquidity than direct real estate investments o Offer diversification independent of the stock market Equity REITs o Buy property directly o Manage the property o Investors hope the real estate appreciates in value Mortgage REITS o Buy mortgages o Investors only receive interest payments on the mortgages o Advantage consistent income Hybrid REITs o Invest in both properties and mortgages o Investments result in both capital appreciation and interest income The cost of Mutual Funds o Load funds sales commissions charged to the investor when ourchasing fund shares o Back end load funds commissions charged to the investor when selling the shares may be sliding scale o No load funds no commission charged Management Fees o Managing a fund costs money Advisor custodian transfer agent underwriter sales commission o Find out finds expense ratio Compares the funds expenses to its assets 25 2 0 o 12 lb 1 fees mutual fund charges share holders for marketing costs 1 Money Market Mutual Funds o invest in short term securities with maturities of less than 30 days o work much like an interest bearing checking account with some limitations o considered practically risk free o require 1000 investment Money Market Funds o Offers the individual investor access to high yielding money marjet instruments without having to pay 100 000 denominations Bank cds Treasury bills 2 Stock Mutual Funds o growth funds small company growth funds growth and income funds sector funds index funds international funds o Growth Goal is capital appreciation o Maximum growth High specialties seeking large profits from capital gains Often buy stock of small unseasoned companies High speculative o Small company Invest in small companies that usually have sales of 100 million or less o International Can invest in one region or area of the world Can invest in specific country o Income Current income is main objective Interest income Dividend income 3 Balanced Mutual Funds o try to balance objectives of long term growth income and stability of the capital invested o invest in common stock preferred stock and bonds o less volatile than stock funds balanced funds o objective is to earn both capital gain and current income high grade common stocks fixed income securities 4 Asset Allocation Funds o are similar t balanced mutual funds in the mix of securities o aggressively more money between stocks and bonds in an attempt to out perform the market o risky due to the turnover rate and associated transaction costs 5 Life cycle Funds o are similar to asset allocation funds o tailor holdings