CHAPTER SIX Investment Companies Mutual l 229 Funds IONS 1. Are mutual funds sub
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Question
CHAPTER SIX Investment Companies Mutual l 229 Funds IONS 1. Are mutual funds subject to federal income taxation? Are distributions from mutua funds taxable? 2. What is a loading charge? Do all investment companies charge this fee? 3. What is a specialized mutual fund? hat differentiates large and small cap funds? Value and growth funds? 4. What advantage do "families" of funds offer? 5. What differentiates a traditional savings account at a commercial bank from a money market mutual fund? Are investments in money market funds as safe as savings ac- counts and certificates of deposit with a commercial bank? 6. What assets do money market mutual funds acquire? Could an individual investor with 12,345 to invest in a safe, short-term security acquire these assets? 7. Should an investor expect a mutual fund to outperform the market? If not, why should the investor buy the shares? 8. What are the differences among loading fees, exit fees, and 12b-1 fees 9. Why may the annual growth in a fund's net asset value not be comparable to the return earned by an individual investor? may beta coefficients be used to standardize returns for risk to permit compari- 10. How 11. sons of mutual when 12 percent, does this If a portfolio manager earned 15 percent the market rose by prove that the manager outperformed the market? investment performance may 12. for that judged on a risk-adjusted basis?Explanation / Answer
1) Mutual Fund Unitholders pay federal taxes. Yes, the distribution by the Mutual fund is taxable to the unitholders.
2)Mutual Fund Companies that uses brokers to sell there units to investors compensate brokers by paying them fees known as sales load charges i.e loading charges. Yes all mutual funds companies charge this fee.
3) A mutual Fund Investing primarily in the securities of a particular Industry, sector, type, etc are known as Specialized Mutual funds.
Small cap fund means the fund which invests its fund in shares of small companies whereas Large cap funds invest its fund in shares of large or big companies.
Growth fund is a fund that gives capital appreciation over the long term. While a value fund invests in shares having low price in relation to factors such as earnings, sales, net current assets, and the book value of the issuing companies.
4) "Families" in Mutual Fund allows significant flexibility in chosing the investments as well as the flexibility to move our money between different investments. Mutual Fund families also offer easy transfers among their funds.
5) A traditional saving account in a commercial bank just gives a investor a fixed rate of return, while a money market mutual fund gives the investor a higher return on its investment. No the money market mutual funds are more risky as they donot carry FDIC insurance,i.e. that you risk your principle as well as any interest you earn.
6)Money market mutual funds invest in short-term, fixed-income securities like US Treasury bills, Commercial Bills, etc. No, a Individual Investor having $12345 cannot invest in these assets because the investment required for these type of assets is very high.
7) Mostly a Mutual fund outperforms the market returns because there are experts in a mutual fund company to manage the portfolio of the fund which would help the mutual fund company to yeild higher returns.
8)Loading Fees :A sales charge or commission charged to an investor when buying or redeeming shares in a mutual fund. The fee may be a one-time charge at the time the investor buys into tund (front-end load), when the investor redeems the mutual fund shares (back-end load), or on an annual basis.
Exit Fees: A fee or charge charged to an investor for withdrawing money prior to a previously stipulated date. This is mostly expressed and charged as a percentage of assets rather than at a flat fee.
12b-1 Fees : Is an annual marketing or distribution fee on a mutual fund. The 12b-1 fee is considered an operational expense and is included in a fund's expense ratio. It is generally between 0.25-1% (the maximum allowed) of a fund's net assets.
9) In a annual growth fund the return which an investor gets at the end of the period is reinvested into the fund i.e. new units of the corresponding return are purchased by the fund, while in a return fund the investor gets the money in cash that the fund has earned at the end of the year, so this is the reason why a growth fund cannot be compared with a return fund.
10) There are mainly three Beta Coefficients to standardise returns of the mutual fund
a) Sharpe Ratio: Excess Return / Standard Deviation
b) Treynors Ratio: Excess Return / Beta
c) Jensens Ratio (Jensens Alpha) : Return on Portfolio (RP) - Expected Return as per CAPM
11) Yes, the portfolio manager has outperformed the market.
12) We have to take the standard deviation of the monthly returns and then annualize it to calculate the volatility. Then we have to correlate these monthly returns with the overall stock market returns to create a beta, and calculate the outperformance to create alpha.