Chapter 3

Charles P. Jones, Investments: Analysis and Management,

12th Edition, John Wiley & Sons

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 Alternative to direct investment in or
ownership of securities
Accomplishes essentially the same thing as direct
investing
Refers to buying and selling the shares of
intermediaries that hold securities in
portfolio
Shares are ownership interest in portfolio entitled
to portfolio income
Shareholders also pay expenses and management
fee

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 Firm that sells shares to the public and uses
the proceeds to invest in marketable
securities
Acts as conduit for distribution of dividends,
interest, and realized gains
Offers professional management
Regulated but not insured or guaranteed by any
federal agency
Shareholders pay taxes as if they directly owned
securities

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 Unit Investment Trust (UIT)
Typically holds an unmanaged, fixed-income
portfolio
Relatively small share of market
Closed-End Investment Company
Actively managed portfolio
Fixed number of shares
Trade on stock exchanges like other stocks

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 Exchange Traded Funds
Portfolio of assets that tracks a sector, region, or
market
Trade like individual equities on exchange
Management fees low
Typically unmanaged portfolios
Tax efficiency
Investor has greater control over realization of
capital gains/losses than with a mutual fund

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 Mutual Funds (Open-end Investment
Companies)
Investors buy fund shares from investment
companies, sell shares back to those companies
Mutual funds not sold on exchanges
Number of shares outstanding constantly
changing (unlike closed-end funds)
Offer diversification, professional management,
other services
Popular with investors, especially in retirement
plans

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 Money Market Funds (MMFs)
Invest in portfolio of money market securities
Taxable or tax-exempt
Investors pay a management fee but not a sales
or redemption charge (load)
Not insured by the federal government
Attempt to keep price at $1/share
Offer investors broad diversification, great
liquidity and a way to earn going money market
rate

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 Equity, bond, and hybrid mutual funds
Equity funds hold primarily stocks, bond funds
primarily hold bonds and hybrid funds hold a
combination
All invest in portfolio of securities consistent with
the objectives of the fund
Companys board sets objects, must specify them
in investment policy
Objectives can be achieved in various ways, so
investment style can also be important

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 Most equity funds are either:
Value funds, which invest in stocks that are cheap
according to standard financial analysis methods
Growth funds, which invest in stocks of firms
expected to show future rapid earnings growth
These fund types tend to perform well at
different times, appeal to investors with
different objectives
Best strategy is probably to hold both fund

types

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Index Funds
Mutual Funds designed to match a market
index
Unmanaged portfolio, typically with low

expense ratio
Expenses vary widely, though, so investors need
to be sure expenses are reasonable
Often outperform actively managed mutual
funds

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Net Asset Value Per Share
(NAV)
NAV is per share value of securities in a
fund
Is the total market value of securities,

minus any liabilities, divided by number of

shares outstanding
Changes daily and is calculated daily after

markets close at 4 p.m.

If no sales charges, NAV is price investors

pay to buy mutual fund or price paid to

investors selling fund

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The Details of Indirect Investing
Closed-end funds
Market prices often differ from NAV
Market price may be less than NAV (discount) or
more than NAV (premium)
Portfolios return calculated based on NAVs
Shareholders return calculated based on closing
prices
Individual investors should avoid purchasing
newly offered shares of closed-end funds

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The Details of Indirect Investing
Mutual Funds
Investors can purchase directly or indirectly
Usually only require a small minimum investment
Investors can redeem shares anytime
Investors purchase/redeem at NAV plus or minus
sales charges
Funds prospectus discloses fees and expenses
Load funds charge a sales fee
No-load funds do not charge a sales fee

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The Details of Indirect
Investing
Mutual Fund Share Classes

Way to give investors choice over fees

Each class has same claim on portfolio, same NAV
No-load funds
Purchased at NAV directly from the investment
company
No sales force expense to cover
Investors must seek out funds
Annual operating expenses paid out of fund income
All funds charge shareholders an expense
ratio

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The Details of Indirect
Investing
Exchange-Traded Funds

Can be bought or sold anytime during the trading

day
Can be bought on margin or sold short
Have much lower expenses than actively
managed funds
Can weight indexes differently, which can affect
return

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 Reported on a regular basis in the popular
press
Price performance not the same as total
return
Total return measures both price changes and
income (from dividends) over a specified time
period
Average annual return is a hypothetical measure
Costs and taxes should also be considered
Expenses may be the best indicator of a
funds performance

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 Some mutual funds specialize in
international securities
Can have higher costs
International funds or global funds emphasize
international stocks
Single-country funds concentrate on one country
Some ETFs match foreign indexes
Not hedged against currency risk

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The Future of Indirect Investing
Mutual fund supermarkets
Investors can buy/sell funds from various mutual
fund families through a single source
Offer fee and no-fee aisles
Hedge Funds
Largely unregulated investment companies
available to private investors
May use leverage, derivatives, other strategies not
available to mutual fund managers
Require substantial initial investment, charge
substantial fees

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