INVESTMENTS | BODIE, KANE, MARCUSCopyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinCHAPTER 4Mutual Funds and Other Investment CompaniesINVESTMENTS | BODIE, KANE, MARCUSInvestment Companies Pool funds of individual investors and invest in a wide range of securities or other assets. Services provided: Administration old investors cash out by selling to new investors Priced at premium or discount to NAV6INVESTMENTS | BODIE, KANE, MARCUSTypes of Investment Companies Other investment organizations Commingled funds REITs Hedge Funds 7INVESTMENTS | BODIE, KANE, MARCUSMutual Funds: Open-End Investment Companies Money Market Equity Sector Bond Balanced Asset Allocation and Flexible Index International8INVESTMENTS | BODIE, KANE, MARCUSTable 4.1 U.S. Mutual Funds by Investment Classification99INVESTMENTS | BODIE, KANE, MARCUSHow Funds Are Sold Direct-marketed funds Sales force distributed Revenue sharing on sales force distributed Potential conflicts of interest Financial Supermarkets 10INVESTMENTS | BODIE, KANE, MARCUSCosts of Investing in Mutual Funds Fee Structure: Four types1. Operating expenses2. Front-end load3. Back-end load4. 12 b-1 charge Fees must be disclosed in the prospectus Share classes with different fee combinations11INVESTMENTS | BODIE, KANE, MARCUSExample 4.2: Fees for Various Classes (Dreyfus Worldwide Growth Fund)12INVESTMENTS | BODIE, KANE, MARCUSFees and Mutual Fund Returns: An ExampleInitial NAV = $20 Income distributions of $.15 Capital gain distributions of $.05 Ending NAV = $20.10:13INVESTMENTS | BODIE, KANE, MARCUSTable 4.2 Impacts of Costs on Investment Performance14INVESTMENTS | BODIE, KANE, MARCUSLate Trading and Market Timing Late trading accepting buy or sell orders after the market closes and NAV is determined Market timing rapid in-and-out trading on stale net asset values Net effect is to transfer value from ordinary shareholders to privileged traders Mutual funds penalized for improper trading. New rules to prevent these practices15INVESTMENTS | BODIE, KANE, MARCUSTaxation of Mutual Fund Income Pass-through status under the U.S. tax code Taxes are paid only by the investor Fund investors do not control the timing of the sales of securities from the portfolio High portfolio turnover leads to tax inefficiency Average turnover = 60%16INVESTMENTS | BODIE, KANE, MARCUSExchange Traded Funds Examples: “spiders”, “diamonds” and “cubes” Potential advantages: Trade continuously like stocks Can be sold short or purchased on margin Lower costs Tax efficient Potential disadvantages: Prices can depart by small amounts from NAV Must be purchased from a broker17INVESTMENTS | BODIE, KANE, MARCUSFigure 4.2 Growth of U.S. ETFs over time18INVESTMENTS | BODIE, KANE, MARCUSTable 4.3 ETF Sponsors and Products19INVESTMENTS | BODIE, KANE, MARCUSMutual Fund Investment Performance: A First Look Performance of actively managed funds: below the return on the Wilshire index in 23 of the 39 years from 1971 to 2009 Evidence for persistent superior performance (due to skill and not just good luck) is weak, but suggestive Bad performance more likely to persist20INVESTMENTS | BODIE, KANE, MARCUSFigure 4.3 Diversified Equity Funds versus Wilshire 5000 Index21INVESTMENTS | BODIE, KANE, MARCUSTable 4.4 Consistency of Investment Results22INVESTMENTS | BODIE, KANE, MARCUSInformation on Mutual Funds Funds prospectus describes: investment objectives Fund investment adviser and portfolio manager Fees and costs Statement of Additional Information (SAI) Funds annual report23INVESTMENTS | BODIE, KANE, MARCUSInformation on Mutual Funds Wiesenbergers Investment Companies Morningstar (www.morningstar.com) Yahoo (biz.yahoo.com/funds) Investment Company Institute (www.ici.org) Directory of Mutual Funds24INVESTMENTS | BODIE, KANE, MARCUSCHAPTER 5Introduction to Risk, Return, and the Historical Record25INVESTMENTS | BODIE, KANE, MARCUSInterest Rate Determinants SupplyHouseholds DemandBusinesses Governments Net Supply and/or DemandFederal Reserve Actions26INVESTMENTS | BODIE, KANE, MARCUSReal and Nominal Rates of Interest Nominal interest rate: Growth rate of your money Real interest rate: Growth rate of your purchasing power Let R = nominal rate, r = real rate and I = inflation rate. Then:27INVESTMENTS | BODIE, KANE, MARCUSEquilibrium Real Rate of Interest Determined by:SupplyDemandGovernment actionsExpected rate of inflation28INVESTMENTS | BODIE, KANE, MARCUSFigure 5.1 Determination of the Equilibrium Real Rate of Interest29INVESTMENTS | BODIE, KANE, MARCUSEquilibrium Nominal Rate of Interest As the inflation rate increases, investors will demand higher nominal rates of return If E(i) denotes current expectations of inflation, then we get the Fisher Equation: Nominal rate = real rate + inflation forecast30INVESTMENTS | BODIE, KAN