Mutual Funds and Other Investment Companies Answer Key Part 4

61. A mutual fund had average daily assets of $3.0 billion in 2009. The fund sold $600 million worth of stock and purchased $700 million worth of stock during the year. The fund's turnover ratio is ___. A. 27.5% B. 12% C. 15% D. 25% E. 20% 600,000,000/3,000,000,000 = 20% 62. A mutual fund had average daily assets of $2.0 billion in 2009. The fund sold $500 million worth of stock and purchased $600 million worth of stock during the year. The fund's turnover ratio is ___. A. 27.5% B. 12% C. 15% D. 25% E. 20% 500,000,000/2,000,000,000 = 25% 63. A mutual fund had average daily assets of $4.0 billion in 2009. The fund sold $1.5 billion worth of stock and purchased $1.6 billion worth of stock during the year. The fund's turnover ratio is ____________. A. 37.5% B. 22% C. 15% D. 45% E. 20% 1,500,000,000/4,000,000,000 = 37.5% 64. A mutual fund had average daily assets of $4.7 billion in 2009. The fund sold $2.2 billion worth of stock and purchased $3.6 billion worth of stock during the year. The fund's turnover ratio is ____________. A. 37.5% B. 22.6% C. 15.3% D. 46.8% E. 20.7% 2,200,000,000/4,700,000,000 = 46.8% 65. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 5.75%. If the securities in which the fund invested increased in value by 11% during the year, and the fund's expense ratio was 1.25%, your return if you sold the fund at the end of the year would be ____________%. A. 4.33 B. 3.44 C. 2.45 D. 6.87 E. 5.16 {[$20 * .9425 * (1.11 − .0125)] -$20}/$20 = 3.44% 66. You purchased shares of a mutual fund at a price of $12 per share at the beginning of the year and paid a front-end load of 4.75%. If the securities in which the fund invested increased in value by 9% during the year, and the fund's expense ratio was 1.5%, your return if you sold the fund at the end of the year would be ____________%. A. 4.75 B. 3.54 C. 2.65 D. 2.39 E. 1.95 {[$12 * .9525 * (1.09 − .015)] − $12}/$12 = 2.39% 67. You purchased shares of a mutual fund at a price of $17 per share at the beginning of the year and paid a front-end load of 5.0%. If the securities in which the fund invested increased in value by 12% during the year, and the fund's expense ratio was 1.0%, your return if you sold the fund at the end of the year would be ____________%. A. 4.75 B. 5.45 C. 5.65 D. 4.39 E. 3.78 {[$17 * .95 * (1.12 − .01)] − $17}/$17 = 5.45% 68. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 6.0%. If the securities in which the fund invested increased in value by 10% during the year, and the fund's expense ratio was 1.5%, your return if you sold the fund at the end of the year would be ____________%. A. 1.99 B. 2.32 C. 1.65 D. 2.06 E. 3.51 {[$20 * .94 * (1.10 − .015)] − $20}/$20 = 1.99% Short Answer Questions 69. List and describe the more important types of mutual funds according to their investment policy and use. Some of the more important fund types, classified by investment policy, are: Money Market Funds - These funds invest in money market securities. They usually offer check-writing features and NAV is fixed at $1 per share, so that there are no tax implications associated with redemption of shares. They provide low risk, relatively low return and high liquidity. Equity Funds - These funds invest primarily in stock, although they may hold other types of securities at the manager's discretion. They may also hold some money market securities to provide liquidity for share redemption. Typical objectives are capital gain, growth, growth and income, income, and income and security. Bond Funds - These funds specialize in fixed-income securities such as corporate bonds, Treasury bonds, mortgage-backed securities or municipal bonds. These funds may specialize by maturity or credit risk as well. Balanced Funds - These funds may substitute for an investor's entire portfolio. They hold a mix of fixed-income and equity securities. Income funds try to maintain safety of principal but achieve liberal current income, while balanced funds seek to minimize risk. Asset Allocation Funds - These funds also hold both stocks and bonds, but vary the proportions in accord with the portfolio manager's forecast of the relative performance of each sector. These funds are engaged in market timing and are therefore higher risk. Index Funds - These funds try to match the performance of a broad market index. They buy shares in securities included in a particular index in proportion to the security's representation in that index. Index funds are a low-cost way for small investors to pursue a passive investment strategy. Specialized Sector Funds - These funds concentrate on a particular industry or industries. Held alone, they are not well diversified and may be higher risk. Feedback: The question is designed to test the student's knowledge of the various types of funds available and their suitability for different needs. 70. Discuss the taxation of mutual fund income. Investment returns of mutual funds are granted "pass-through status" under the U.S. tax code, meaning that taxes are paid only by the investor in the mutual fund, not by the fund itself. The income is treated as passed through to the investor as long as all income is distributed to shareholders. Investors will pay taxes at the appropriate rate depending on the type of income. One drawback is that investors cannot time the sale of securities for maximum tax advantage, unless the funds are held in tax-deferred retirement accounts. Feedback: The purpose of the question is to determine whether students understand the tax differences of owning mutual funds as compared to individual investments. 71. What is an Exchange-traded fund? Give two examples of specific ETFs. What are some advantages they have over ordinary open-end mutual funds? What are some disadvantages? ETFs allow investors to trade index portfolios. Some examples are spiders (SPY), which track the S&P500 index, diamonds (DIA), which track the Dow Jones Industrial Average, and qubes (QQQQ), which track the NASDAQ 100 index. Other examples are listed in Table 4-3. Advantages 1. ETFs may be bought and sold during the trading day at prices that reflect the current value of the underlying index. This is different from ordinary open-end mutual funds, which are bought or sold only at the end of the day NAV. 2. ETFs can be sold short. 3. ETFs can be purchased on margin. 4. ETFs may have tax advantages. Managers are not forced to sell securities from a portfolio to meet redemption demands, as they would be with open-end funds. Small investors simply sell their ETF shares to other traders without affecting the composition of the underlying portfolio. Institutional investors who want to sell their shares receive shares of stock in the underlying portfolio. 5. ETFs may be cheaper to buy than mutual funds because they are purchased from brokers. The fund doesn't have to incur the costs of marketing itself, so the investor incurs lower management fees. Disadvantages 1. ETF prices can differ from NAV by small amounts because of the way they trade. This can lead to arbitrage opportunities for large traders. 2. ETFs must be purchased from brokers for a fee. This makes them more expensive than mutual funds that can be purchased at NAV. 72. Discuss the consistency of mutual fund performance results, as studied by Goetzmann and Ibbotson (1994) and Malkiel (1995). Goetzmann and Ibbotson found that, of mutual funds that performed in the top half of their categories during an initial period, 62% remained "winners" during the subsequent two-year period. The other 38% became "losers". Of the funds that performed in the bottom half of their categories during the initial period, 63.4% remained "losers" in the subsequent two-year period, while 36.6% became "winners". If performance were purely random, the percentages would be 50%. If performance were due entirely to the skill of the managers, all winners should remain winners and all losers should remain losers. The results of the study indicate that there seems to be some skill involved in fund performance trends. Malkiel broke his study into two time periods. For the 1970s he found results similar to Goetzmann and Ibbotson. For the 1980s his percentages were much closer to 50%, which indicates that performance seemed to be more random during this period. Malkiel used oneyear returns rather than two-year returns.