Finance 301 1st Edition Lecture 16Outline of Last Lecture I. Background on mutual fundsII. Mutual funds categoriesIII. Management of mutual fundsOutline of Current LectureIV. Money Market FundsV. Other Types of FundsVI. Performance of Mutual FundsVII. Valuation of Bond Mutual FundsCurrent LectureI. Money Market Fundsa. What is a money market fund?i. Fund that invests in money market securitiesb. Why would we invest in these funds instead of stock and bond mutual funds?i. Diversify and provide less risk, can liquidate very quickly in and outc. What are their assets?i. Their assets are treasury bills, commercial paper, certificates for deposit, d. What is their risk?i. No term risk, no liquidity risk, has default risk but it is very small these investments 99% are good. VERY safe investments get in andget out ii. Interest rate risk- fear of quickly rising interest ratesII. Other Types of Fundsa. Private Equity Fundsi. Private equity funds pool money provided by individual and institutional investors and buy majority (or entire) stakes in businesses.ii. What do they try and accomplish?1. Trying to make higher returns, need to have about 100,000to get in . They pool money and buy companiesb. Exchange-Traded Fundsi. Designed to mimic particular stock indexes. ii. What are the major difference between ETFs and mutual funds?iii. These are closed end funds, not opened end funds. They do not issue new shares all of the time. Sell the ETF to investors like an IPO and then they sell between themselves. ETFs may only be 25stocks instead of 75 or 100. Based on a sector. People like these because they are expecting higher returns and there is more risk here you are trading between investors. Expected to move up and down like the securities that are in the etiv. Examples include PowerShares (QQQ), or Cube (QQQQ), which represents the Nasdaq 100 index of technology firms.v. Another popular ETF is the Standard & Poor’s Depository Receipt (SPDR or Spider), representing the S&P 500 index.c. Hedge Fundsi. Another investment fund, but usually closed end funds and much more expensive than open-end mutual funds.ii. They differ in several ways:1. Require a much larger initial investment (such as $1 million).2. Many hedge funds are not “open” in the sense that they may not always accept additional investments or accommodate redemption requests unless advance notice is provided.3. Hedge funds have been subject to minimal regulation.4. Hedge funds invest in a wide variety of investments to achieve high returns.5. Big time money 6. Very risky tell them straight up like private equity expectingto make 15 or 20% 7. Play derivates/ anything d. Use of Financial Leveragei. What do I mean by financial leverage?1. Borrowing money. They borrow money to invest because you are expecting to make more money than the interest rate2. ROI return on investment and ROE return on equity here we are looking at ROE e. Hedge Fund Feesi. Charge management feesii. Charge incentive fees iii. Take wealthy people money and invest it they charge 1 to 2% a year not as expensive as mutual funds but it is still a cost they also make money from incentive fees where they charge generally around 20% of profits. f. Performance of Hedge Funds during the Credit Crisisi. Some hedge funds failed during the credit crisis in 2008. Why? They were invested in mortgage backed securities and failed, lost it when real estate went bad. g. Short Selling by Hedge Fundsi. During the credit crisis in 2008, hedge funds were accused of making market conditions worse. Why would they make conditions worse? They sold short. Hoping price of the stock drops, h. Madoff Fund Scandali. What did Bernard Madoff do? Ponzi Scheme, he convinced peopleto invest in him but all you are doing is passing money around from people who invested. Promised them a 10% return. Telling them to buy stocks and buy auctionsii. How was he able to do continue as a hedge fund for so long? He was able to do this because he was a well liked person and a good salesman, one of the largest trader on NASDAQ. All of the people wanted to get out when the market collapses. He defaulted on his investors cause he was just spending money himself, he couldn’t afford to pay his investors back iii. The potential losses to investors were estimated to be as high as $50 billion, making this possibly the biggest financial scandal in U.S. history.i. Regulatory Reform of Hedge Fundsi. The Financial Reform Act of 2010 contained provisions to stabilize the financial system.ii. Mandates that hedge funds managing more than $100 million register with the SEC as investment advisors.iii. Must also disclose financial data that can be used by the Financial Stability Oversight Council (created by the Financial Reform Act) inorder to assess systemic risk in the financial system.iv. Prevents commercial banks from investing more than 3% of their capital in hedge funds, private equity funds, or real estate funds.j. Real Estate Investment Trustsi. Real estate investment trusts can be classified as – stocks on real estate companiesii. Equity REITs – invest directly in property a lot of them are certain types of real estate such as apartment, hotels, ectiii. Mortgage REITs – invest in mortgages and mortgage backed securities these were the ones that really got hurt during the financial crisisiv. Hybrid REITs – invest in properties and mortgagesv. Sell for cheap like regular stocks act like large cap stocksWhat happened during the credit crisis? They had trouble during the crisis because all real estate was going down in value but so did the wholestock market. vi. REITS pay out a high dividend you will definitely get a dividendk.III. Performance of Mutual Fundsa. Change in Market Conditionsb. Change in Sector Conditionsc. Change in Management Abilitiesd. ΔV = f(ΔMKT, ΔSECTOR, ΔMANAB)e. + + +f. Note that the sign on the SECTOR is different than what is in the text.g. If sector goes up, They go up h. Management goes up they go upIV. Valuation of Bond Mutual Fundsa. ΔV = f(ΔRf, ΔRP, ΔMANAB)b. Change in risk free rate occurs or change in risk premium occurs on interest rates they go up or downc. Risk premium goes down bond mutual fund go up in value