CHAPTER TWENTY-THREE

INVESTMENT COMPANIES

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INVESTMENT COMPANIES ‡ INVESTMENT COMPANIES DEFINITION: a type of financial intermediary who obtain funds from investing to use in purchase of financial assets ± investors receive certain rights in exchange 2 .

lower commission rate ± provides diversification ‡ professional management ± manager is a professional seeking mispriced securities full time 3 .INVESTMENT COMPANIES ‡ INVESTMENT COMPANIES ± Advantages to the Individual Investor ‡ economies of scale ± higher volume purchases.

NET ASSET VALUE ‡ KEY CONCEPT FOR INVESTMENT COMPANIES ± Net Asset Value (NAV) NAVt = (MVAt .LIABt )/NSOt where NAVt is the firm¶s net asset value MVAt is the market value of firm¶s assets LIABt is the dollar value of firm¶s liabilities NSOt is the number of shares outstanding 4 .

MAJOR TYPES OF INVESTMENT COMPANIES ‡ UNIT INVESTMENT TRUST ± DEFINITION: an investment company that owns a fixed set of securities for the life of the company ± FORMATION ‡ ‡ ‡ ‡ sponsor purchases a specific set of securities the securities are deposited with trustee firm sells redeemable trust certificates to the public all income received by trustee paid out to certificate holders 5 .

MAJOR TYPES OF INVESTMENT COMPANIES ‡ UNIT INVESTMENT TRUST ± LIFE SPANS ‡ from 6 months to 20 years ± SECONDARY MARKET ‡ investor may sell the shares back to the trust ‡ a secondary market may be maintained by the sponsor of the trust .

MAJOR TYPES OF INVESTMENT COMPANIES ‡ MANAGED COMPANIES ± WHAT ARE THEY? ‡ organized as corporations with a board of directors ‡ management company is hired ‡ annual management fees vary from .5 to 1% of the average market value of the company¶s total assets 7 .

MAJOR TYPES OF INVESTMENT COMPANIES ‡ CLOSED-END INVESTMENT COMPANY ± FEATURES ‡ ‡ ‡ ‡ shares are traded on an exchange unlimited life dividends received paid out to shareholders can issue shares to raise additional funds ± quotations ‡ market prices published daily ‡ NAV published weekly 8 .

MAJOR TYPES OF INVESTMENT COMPANIES ‡ OPEN-ENDED INVESTMENT COMPANIES ± most known as mutual funds ± continuously offer new shares to the public ± capitalization is open 9 .

MUTUAL FUNDS ‡ MUTUAL FUND TAXATION ± re. the investment company: ‡ no corporate income tax liability if ± it pays at least 90% of its net income to shareholder ± Two kinds of payments to investors: » one for income » another for net capital gains realized 10 .

NAVt-1) +It + Gt}/ NAVt-1 where rt = return at time t It = income Gt = capital gain distribution at time t 11 .MUTUAL FUNDS ‡ MUTUAL FUND PERFORMANCE ± CALCULATING RETURNS: ‡ Formula: rt = {(NAVt.

MUTUAL FUNDS ‡ AVERAGE RETURN ± Benchmark portfolio used tom compare the performance of the investment company ± Composition of the benchmark portfolio ‡ a market index is chosen (e. T-bills) ‡ an index to account for the difference in performance is chosen ± allows for high to low book-to-market price stocks 12 .g.g. S&P500) ‡ a risk-free asset chosen (e.

arbp where ar p = the average return on portfolio p arbp = average return on the benchmark 13 .MUTUAL FUNDS ‡ AVERAGE RETURN ± Style Analysis ‡ used to derive appropriate benchmark ± Ex Post Alpha Derived ‡ formula: Ep !arp .

MUTUAL FUNDS Ep !arp .arbp If Ep > 0. the portfolio has performed well 14 .

MORNINGSTAR: ‡ performance comparisons using S&P500 for all equity and bond funds ± may not be appropriate for certain types of funds ± e. a fund mostly invested in NASDAQ stocks does not compare 15 .g.EVALUATING MUTUAL FUNDS ‡ PROFESSIONAL SERVICES ± MORNINGSTAR ‡ is the most often used service ± CAVEATS RE.

EVALUATING MUTUAL FUNDS ‡ PROFESSIONAL SERVICES ± MORNINGSTAR ‡ is the most often used service ± CAVEATS RE. MORNINGSTAR: ‡ their approach to the quest for abnormal returns is not clearly revealed ‡ use of peer group comparisons has several serious shortcomings ± some funds may be restricted by their stated objectives as to what they can purchase 16 .

EVALUATING MUTUAL FUNDS ‡ PROFESSIONAL SERVICES ± MORNINGSTAR ‡ is the most often used service ± CAVEATS RE. MORNINGSTAR: ‡ survivorship bias ± the tendency for poorly performing funds to go out of business and leave the peer group 17 .

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