Maddie Norton Chapter 15 Period 2 1) What is a mutual fund?

What makes a mutual fund different from owning a stock or bond directly? Mutual Fund: An investment fund that raises funds from investors, pools the money, and invests it in stocks, bonds, and other investments. Each investor owns a share of the fund proportionate to the amount of his or her investment. 2) List and explain the seven advantages associated with owning a mutual fund. Which of these advantages relates to Principle 8? How? Diversification: Mutual Funds are an inexpensive way to diversify. For the small investor, this is an extremely important benefit. If you have only $10,000 to invest, it would be difficult to diversify your holdings without paying commissions. Professional Management: A mutual fund is an inexpensive way to gain access to professional management. Because fund managers control millions and sometimes even billions of dollars in assets and make huge securities transactions, they have access all the best research from several brokerage houses. Minimal Transaction Costs: Because mutual funds trade in such large quantities, they pay far less in terms of commissions. For example, if you were trading stocks valued at less that $1,000, the brokerage fee might run up to 50 cents per share. Liquidity: Mutual funds are easy to buy and sell--just up the phone or go online. Flexibility: Given that there are over 8,000 different mutual funds to choose from, it should come as no surprise that they cover many objectives and risk levels. Service: Mutual funds provide you with a number of services that just wouldnt be available if you invested individually. For example they provide bookkeeping services, checking accounts, automatic systems to add to or withdraw from your account, and the ability to buy or sell with a single phone call. Avoidance of Bad Brokers: With a mutual fund you avoid the potentially bad advice, high sales commissions, and churning that can come with a bad broker. 3) List and explain the five disadvantages of mutual funds. Lower-than-market performance: On average, approximately 80 percent of actively managed stock mutual funds (non-index mutual funds) underperform the market (the S&P 500 Index). Costs: The costs associated with investing in mutual funds can vary dramatically from fund to fund; investigate their costs before investing. Some funds charge a sales fee or load that can run as high as 8.5 percent, in addition to an annual expense ratio that can run up to 3 percent. Risks: Not all mutual funds are truly safe. In an attempt to beat the competition, many funds have become specialized or segmented. When mutual funds focus on small secto rs of the market, such as health/biotechnology stocks or Latin America, they may be diversified within that sector of the market, but they are not diversified across all the different market sectors. You Cant Diversify Away a Market Crash: Many investors view the diversification of mutual funds as eliminating all risk. You should know better. Taxes: When you invest using a buy-and-hold strategy, you can assure yourself of long-term capital gain, and you dont pay taxes, on your capital gains until you sell your stock. Mutual funds, though, tend to trade relatively frequently, and when they sell a security for a profit, you have to pay taxes, on your capital gains. Mutual funds dont let you defer your taxes--they make you pay as you go. 4) If diversification is a primary advantage of mutual funds, why cant a mutual fund diversify away systematic risk? Because there is more risk with diversification. 5) Mutual fund investors make money in three ways. Name and briefly describe each. How are these reflected in the formula for calculating total return?

8) Define net asset value. When is the net asset value of a mutual fund calculated? Net Asset Value: The dollar value of a share in a mutual fund. Its the value of the funds holdings (minus any debt ) divided by the number of shares outstanding. The price you receive when you sell your shares 9) How do closed-end funds differ from open-end funds? What asset class dominates the closed-end mutual fund market? Open End: A mutual fund that has the ability to issue as many shares as investors want the value of all the investments that the fund holds determines how much each share in the mutual fund is worth. Asset Class That Dominates the Closed-End Mutual Fund Market: The number shares. Closed-End:A mutual fund that cant issue new shares. These funds raise money only once by issuing a fixed number of shares, and thereafter the shares can be traded between investors. The value of the investments the fund holds and investor demand for the shares in the fund. 10) What is an REIT and how is one similar to and different from a mutual fund? REIT: An investment vehicle similar to a mutual fund that specializes in real estate investments, such as shopping center or rental property, or that makes real estate loans. Same: Everything is in one spot. Different: Different investments. 11) What is a hedge fund? Why are they not a recommended investment for most investors? Hedge Fund: An investment fund that is private, largely unregulated, and very risky which charges very high fees and only allows wealthy investors to invest. They arent recommended because they are very risky. 12) What is the primary difference between a load fund and a no-load fund? What is a back-end load? A 12b-1 fee? Load Fund: A mutual fund on which a loan or sales commission is charged. No-Load Fund; A Mutual fund that doesnt charge a commission. Back-End Load: A commission thats charged only when the invest liquidates his or her holdings. 12b-1 Fee: An annual fee, generally ranging from 1/4 to 1 percent of a funds assets, that the mutual fund charges its shareholders for marketing costs.