Finance - Chapter 4 Notes Investment Answer Key

1) Mutual funds provide the following for their shareholders. A. Diversification B. Professional management C. Record keeping and administration D. All of these choices are correct. 2) Rank the following fund categories from likely most risky to likely least risky: 1. Equity growth fund 2. Balanced fund 3. Sector fund 4. Money market fund a. 4, 1, 3, 2 b. 3, 2, 4, 1 c. 1, 2, 3, 4 d. 3, 1, 2, 4 3) Which of the following result in a taxable event for investors in mutual funds? 1. Short-term capital gain distributions from the fund 2. Dividend distributions from the fund 3. Long-term capital gain distributions from the fund a. 1 only b. 2 only c. 1 and 2 only d. 1, 2, and 3. (Mutual funds possess the characteristic of passthrough taxation.) 4) Net asset value is defined as _______. A. book value of assets divided by shares outstanding B. book value of assets minus liabilities divided by shares outstanding C. market value of assets divided by shares outstanding D. market value of assets minus liabilities divided by shares outstanding (NAV = Market value of assets minus liabilities/Shares outstanding) 5) Assume that you have recently purchased 100 shares in an investment company. Upon examining the balance sheet, you note that the firm is reporting $225 million in assets, $30 million in liabilities, and 10 million shares outstanding. What is the net asset value (NAV) of these shares? A. $25.50 B. $22.50 C. $19.50 D. $1.95 Explanation NAV = Market value of assets minus liabilities/Shares outstanding =! ($225,000,000!−!$30,000,000)/ 10,000,000 !=!$19.50 6. Investors who want to liquidate their holdings in a closed-end fund may _______. A. sell their shares back to the fund at a discount if they wish B. sell their shares back to the fund at net asset value C. sell their shares on the open market D. sell their shares at a premium to net asset value if they wish 7. _______ fund is defined as one in which the fund charges a sales commission to either buy into or exit from the fund. A. A load B. A no-load C. An index D. A specialized-sector 8. Which of the following is a false statement regarding open-end mutual funds? A. They offer investors a guaranteed rate of return. B. They offer investors a well-diversified portfolio. C. They redeem shares at their net asset value. D. They offer low-cost diversification. 9. _______ funds stand ready to redeem or issue shares at their net asset value. A. Closed-end B. Index C. Open-end D. Hedge. 10. Higher portfolio turnover: 1. Results in greater tax liability for investors 2. Results in greater trading costs for the fund, which investors have to pay for 3. Is a characteristic of asset allocation funds A. 1 only B. 2 only C. 1 and 2 only D. 1, 2, and 3 11. _______ are often called mutual funds. A. Unit investment trusts B. Open-end investment companies C. Closed-end investment companies D. REITs 12. An official description of a mutual fund's planned investment policy can be found in the fund's _______. A. prospectus B. indenture C. investment statement D. 12b-1 forms 13) Mutual funds that hold both equities and fixed-income securities in relatively stable proportions are called _______. A. income funds B. balanced funds C. asset allocation funds D. index funds 14. Specialized-sector funds concentrate their investments in _______. A. bonds of a particular maturity B. geographic segments of the real estate market C. government securities D. securities issued by firms in a particular industry 15. The SEC requires funds to disclose: 1. After-tax returns for the past year 2. After-tax returns for the last 5-year period 3. The tax impact of portfolio turnover A. 1 only B. 1 and 2 only C. 1 and 3 only D. 1, 2, and 3 16. Consider a mutual fund with $300 million in assets at the start of the year and 12 million shares outstanding. If the gross return on assets is 18% and the total expense ratio is 2% of the yearend value, what is the rate of return on the fund? A. 15.64% B. 16% C. 17.25% D. 17.50% Explanation Asset!Value:!$300,000,000!×!1.18!=!$354,000,000 Expenses:!0.02!×!$354,000,000!=!$ Holding!Period!Return:! ($354,000,000!−!$7,080,000!−!$300,000,000)/ $300,000,000 !=!0.1564=15.64% 17. Consider a no-load mutual fund with $200 million in assets and 10 million shares at the start of the year and with $250 million in assets and 11 million shares at the end of the year. During the year investors have received income distributions of $2 per share and capital gain distributions of $.25 per share. Assuming that the fund carries no debt, and that the total expense ratio is 1%, what is the rate of return on the fund? A. 11.19% B. 23.75% C. 24.64% D. The answer cannot be determined from the information given. ' Explanation Nav0=! ($200,000,000/ 10,000,000)=!$20 Nav1=! $250,000,000!×!(1!−!0.01)/11,000,000=!$22.50 HPR!=!$22.50!+!$2.00!+!$0.25!−!$20.00/ $20.00=!23.75% 18. Consider a no-load mutual fund with $400 million in assets, 50 million in debt, and 15 million shares at the start of the year and with $500 million in assets, 40 million in debt, and 18 million shares at the end of the year. During the year investors have received income distributions of $0.50 per share and capital gain distributions of $0.30 per share. If the total expense ratio is 0.75%, what is the rate of return on the fund? A. 12.09% B. 12.99% C. 8.25% D. The answer cannot be determined from the information given. Explanation Since this is a no-load fund, all charges are already embedded in gross return. Thus, gross return and net return are the same. Nav0=!($400,000,000!−!$50,000,000)/15,000,000 =!$23.33 Nav1=!$500,000,000!×!(1−!0.0075)!−!$40,000,000/ 18,000,000=!$25.35 HPR!=!($25.35!+!$0.50!+!$0.30!−!$23.33)/$23.33=!12.09% 19. If you place an order to buy or sell a share of a mutual fund during the trading day, the order will be executed at _______. A. the NAV calculated at the market close at 4 pm New York time B. the real time NAV C. the NAV delayed 15 minutes D. the NAV calculated at the opening of the next day's trading 20. The Stone Harbor Fund is a closed-end investment company with a portfolio currently worth $300 million. It has liabilities of $5 million and 9 million shares outstanding. If the fund sells for $30 a share, what is its premium or discount as a percent of NAV? A. 9.26% premium B. 8.47% premium C. 9.26% discount D. 8.47% discount NAV"="($300,000,000"−"$5,000,000)/9,000,000="$32.78 Discount"="$32.78"−"$30.00"="$2.78 Discount"as"percent"of"NAV"="($2.78/$32.78)="0.0847"="8.47% 21. The Wildwood Fund sells Class A shares with a front-end load of 5% and Class B shares with a 12b-1 fee of 1% annually. If you plan to sell the fund after 4 years, are Class A or Class B shares the better choice? Assume a 10% annual return net of expenses before the 12b-1 fee is applied. A. Class A. B. Class B. C. There is no difference. 22. Advantages of ETFs over mutual funds include all but which one of the following? A. ETFs trade continuously, so investors can trade throughout the day. B.ETFs can be sold short or purchased on margin, unlike fund shares. C. ETF providers do not have to sell holdings to fund redemptions. D. The answer cannot be determined from the information given. D. ETF values can diverge from NAV. Explanation 23. The offer price of an open-end fund is $18 and the fund is sold with a front-end load of 5%. What is the fund's NAV? Assume $100 is invested. (the initial amount invested is inconsequential, the results will be the same). Compare the results after four years: A. $18.74 Value Class!A=!$100!×!(1!−!0.05)!×! 1.10(^4)=!$139.09 Value Class!B=!$100!×!(1!+!0.10!−!0.01) (^4)=!$141.16 Class B is the better choice. B. $17.10 C. $15.40 D.$16.57 Explanation $18 × (1 − 0.05) = $17.10 24. A mutual fund has $50 million in assets at the beginning of the year and 1 million shares outstanding throughout the year. Throughout the year assets grow at 12%. The fund imposes a 12b-1 fee on all shares equal to 1%. The fee is imposed on year-end asset values. If there are no distributions, what is the end-of-year NAV for the fund? A. $50 B. $55.44 C. $56.12 D. $54.55 Explanation $50,000,000!×!1.12!×!(1!−!0.01)/1,000,000=!$55.44 25. The assets of a mutual fund are $25 million. The liabilities are $4 million. If the fund has 700,000 shares outstanding and pays a $3 dividend, what is the dividend yield? A. 5% B. 10% C. 15% D. 20% NAV!=!($25,000,000!−!$4,000,000)/700,000=!$30.00 Dividend!Yield!=!$3.00/$30.00=!0.10!=!10% Dividend yield = 3/30 = 10% 26. Which one of the following statements about returns reported by mutual funds is not correct? A. Reported returns are net of management expenses. B. Reported returns are net of 12b-1 fees. C. Reported returns are net of brokerage fees paid on the fund's trading activity. D. None of these options are correct. (All of the items are included in reported returns.) 27. You are considering investing in a no-load mutual fund with an annual expense ratio of 0.60% and an annual 12b-1 fee of 0.75%. You could also invest in a bank CD paying 6.50% per year. What minimum annual rate of return must the fund earn to make you better off in the fund than in the CD? A. 7.10% B. 7.45% C. 7.25% D. 7.85% Explanation r > 0.065 + 0.006 + 0.0075 = 0.0785 = 7.85% 28. Which type of fund is often priced at a significant discount to net asset value? A. Open-end fund B. Closed-end fund C. Hedge fund D. ETF 29. Which type of fund generally has the lowest average expense ratio? A. Actively managed bond funds B. Hedge funds C. Indexed funds D. Actively managed international funds 30. Disadvantages of ETFs include all of the following except: A. investors incur a bid-ask spread when purchasing. B. investors must pay a broker fee when purchasing. C. prices are only quoted once each day. D. prices can depart from NAV at times.