Chapter Objectives

 Explain the concept of mutual fund operation

 Explain various types of mutual funds
 Describe the various types of stock mutual
funds
 Describe the characteristics of money market
funds
Background on Mutual Funds

 Mutual funds offer a way for small investors

to diversify when they could not do so on their
own with the purchases of individual stocks
 Comparison to depository institutions
 Like depository institutions, mutual funds
repackage proceeds from individuals to make
investments
Background on Mutual Funds
 Regulation of Mutual Funds
Mutual Fund must register with the Securities and Exchange
Commission & provide interested investors with a prospectus.
Information Contained in a Mutual Fund Prospectus
 The minimum amount of investment required
 The investment objective of the fund
 The return on the fund over the past year, the past three years
and the past five years
 The exposure of the fund to various types of risk
 Services offered by the mutual fund
• Check writing
• Telephone or Internet funds transfer
 Management fees incurred that investors pay
Background on Mutual Funds

Pricing shares of the mutual Fund

The price per share of a mutual fund is equal to the net
asset value (NAV= A-L) per share.
Estimating the net asset value
 Net asset value is the value per share
 NAV is estimated daily
 Determine the market value of all the securities in the fund
 Any interest or dividends accrued are added to the market
value
 Any expenses are subtracted
 Divided by the number of shares outstanding
Mutual Fund Distributions to Shareholders

Mutual funds can generate returns to their shareholders in

three ways.
First, they can pass on any earned income (from dividends
or coupon payments) as dividend payments to the
shareholders.
Second, they distribute the capital gains resulting from the
sale of securities within the fund.
A third type of return to shareholders is through mutual
fund share price appreciation. As the market value of a
fund’s security holdings increases, the fund’s NAV
increases, and the shareholders benefit when they sell their
mutual fund shares.
Mutual Funds Categories

 Mutual fund classifications depend on the type

of securities the fund invests in and can include
 Stock or equity mutual funds- An equity fund is a
mutual fund that invests principally in stocks.
 Bond mutual funds- A bond fund is simply a mutual
fund that invests solely in bonds.
 Money market mutual funds- A money market fund is
a kind of mutual fund that invests in highly liquid, near-term
instruments

 Exhibit 23.6 Distribution of Investment in Mutual

Funds
Background on Mutual Funds

 Management of mutual funds

Each mutual fund is managed by one or more portfolio
managers, who must focus on the stated investment objective
of that fund.
Managers invest in a portfolio of securities to meet the
objectives of the fund
Managers adjust the composition of their portfolios in
response to market and economic conditions
They prefer liquid securities that can easily be sold in the
secondary market at any time.
Background on Mutual Funds
 Expenses
 Fees include management plus record-keeping and clerical
fees
 Expense ratio = annual expenses/fund NAV
 Investor should compare expense ratios
 Corporate control by mutual funds
 Mutual funds are large shareholders in companies whose
stock they hold
Since mutual funds invest large amounts of money in some stocks, they
become major shareholders of firms.
 Managers may serve on the board of directors of
companies in which the fund invests
Load versus No-Load Mutual Funds

Classification refers to whether or not there is a sales

charge
No-load means funds are promoted, bought and sold
directly via the mutual fund. A no-load fund is a mutual
fund in which shares are sold without a commission or
sales charge.
Load funds
 Promoted by registered representatives of
brokerage firms who get a commission
 Investors pay the sales charge
Open-End versus Closed-End Funds

 Open-end “mutual” funds

 Willing to repurchase investor shares at any time
 Number of shares outstanding does not remain constant
 NAV determined by fund daily

 Closed-end funds
 Mutual fund does not repurchase the shares they sell—
similar to direct common stock investment
 Number of outstanding shares is constant
 Value of shares related to expectations of portfolio and
determined in market
Stock Mutual Fund Categories

The more popular stock mutual fund categories

include:
1. Growth funds
2. Capital appreciation funds
3. Growth and income funds
4. International and global funds
5. Specialty funds
6. Index funds
7. Multifund funds
Stock Mutual Fund Categories

 Growth funds for investors who want high

returns with moderate risk
 Mutual fund invests in companies that are
expected to grow at a higher than average rate
 Generate an increase in investment value rather
than steady income
 Capital appreciation or aggressive growth
funds
 High but unproven growth potential stocks
 Higher risk
Stock Mutual Fund Categories

 Growth and income funds try to offer growth

but with some stability of income
 International and global funds allow
investment in foreign securities without the
costs involved in purchasing and monitoring
individual stocks
 Returns affected by stock prices
 Returns also affected by foreign exchange rates
 A global mutual fund invests in assets around
the world including the home country.
Stock Mutual Fund Categories

 Specialty funds focus on a group of

companies sharing a particular characteristic
 Index funds are designed to simply match the
performance of an existing stock index
 Multifund funds invest in a portfolio of
different mutual funds
 More diversified
 Involves higher expenses
Exhibit 23.7 Growth in Number of
Equity and Bond Funds
8000

Bond Funds
7000

6000 S tock Funds

5000

4000

3000

2000

1000

0
1978 1985 1990 1995 1999 2001
Year
Growth and Size of Mutual Funds

 Volume and mix in the kind of funds varies

over time
 Overall investment via mutual funds much
higher in recent years
 New kinds of funds target customers with
different risk preferences
Money Market Funds (MMF)

 Money market funds are portfolios of short-

term assets
 Can include check-writing privileges for investors
 Number of checks per month may be restricted
 Shareholders get periodic statements
 Liquid, “cash” balance for investor
Money Market Funds

 Asset composition of money market funds

 Individual funds concentrate in assets that reflect
the fund’s objective
 Money market securities of varying maturity

 Maturity of money market funds

 Varies over time with market conditions
 Risk increases with term
Money Market Funds

 Risk of money market funds

 Credit risk minimized by the short-term nature of
maturities
 Returns for money market funds fall as interest
rates in the economy fall
 Expected returns are low relative to stock and
bond funds
 Consistent positive returns over time
 Lower credit risk
 Lower interest rate risk
Money Market Funds

 Management of money market funds

 Managers try to maintain the overall objective of
the fund
 Manage the composition of the assets
 Investors have a variety of choices when it comes
to money market funds
Hedge Funds

 A hedge fund is a type of actively managed

fund that focuses on high risk high return
investments.
 Hedge funds sell shares to wealthy investors and
financial institutions