1 Chapter 23 Mutual Fund Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Background on mutual funds  Stock mutual fund categories  Bond fund categories  Growth and size of mutual funds  Performance of mutual funds  Mutual fund scandals 3 Chapter Outline (cont’d)  Money market funds  Hedge funds  Real estate investment trusts  Interaction with other financial institutions  Use of financial markets  Globalization through mutual funds 4 Background on Mutual Funds  Mutual funds:  Serve as a financial intermediary by pooling investments by individual investors and using the funds to accommodate financing needs by governments and corporations in the primary market  Frequently invest in securities in the secondary market  Provide an important service for individuals who wish to invest funds and diversify  Offer liquidity if they are willing to repurchase an investor’s shares upon request  Offer various different services, such as transfers between funds and check-writing privileges 5 Background on Mutual Funds (cont’d)  A mutual fund hires portfolio managers to invest in a portfolio of securities that satisfies the desires of investors  The portfolio composition is adjusted in response to changing economic conditions  The board of directors:  Monitors management  Establishes procedures  Ensures that the fund is properly serving its shareholders  Under new SEC rules, a majority of board members must be outsiders 6  Types of funds  Open-end funds:  Are open to investment from investors at any time  Allow investors to purchase or redeem shares at any time  Have a constantly changing number of shares  Maintain some cash in case redemptions exceed investments  Consist of many different categories to satisfy investors’ investment needs Background on Mutual Funds (cont’d) 7  Types of funds (cont’d)  Closed-end funds:  Do not repurchase shares they sell  Require investors to sell the shares on a stock exchange  Have a constant number of outstanding shares  Have an asset size that is about 1/40 th of the asset size of open-end funds  Focus primarily on bonds and other debt securities Background on Mutual Funds (cont’d) 8  Types of funds (cont’d)  Exchange-traded funds:  Are designed to mimic particular stock indexes and are traded on a stock exchange  Differ from open-end funds in that their shares are traded on an exchange, and their share price changes throughout the day  Consist of a fixed number of shares  Are not actively managed  Have become very popular in recent years  Typically do not have capital gains and losses that must be distributed to shareholders Background on Mutual Funds (cont’d) 9  Types of funds (cont’d)  Hedge funds:  Sell shares to wealthy individuals and financial institutions and use the proceeds to invest in securities  Differ from open-end funds because:  They require a much larger initial investment  They may not always accept additional investments or accommodate redemption  They are unregulated and provide very limited information to prospective investors  They invest in a wide variety of investments to achieve high returns Background on Mutual Funds (cont’d) 10  Comparison to depository institutions  Mutual funds repackage the proceeds from individuals to make various types of investments  Investing in mutual funds represents partial ownership  Investors share the gains or losses generated by the fund  Regulation and taxation  Mutual funds must register with the SEC and provide a prospectus  Mutual funds are regulated by state laws  If a mutual fund distributes 90 percent or more of its taxable income to shareholders, it is exempt from taxes on dividends, interest, and capital gains Background on Mutual Funds (cont’d) [...]... foreign securities  Returns on international funds are affected by the foreign companies’ stock prices and the movements of the currencies that denominate the stocks  Global funds include some U.S stocks 23 Stock Mutual Fund Categories (cont’d)  Specialty funds focus on a group of companies sharing a particular characteristic  e.g.,  Index funds are designed to match the performance of an existing stock . 1 Chapter 23 Mutual Fund Operations Financial Markets and Institutions, 7e, Jeff Madura. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Background on mutual funds  Stock mutual fund categories