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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.
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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
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Chapter Outline (cont’d)

Money market funds

Hedge funds

Real estate investment trusts

Interaction with other financial institutions


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
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
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


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)
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
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

(cont’d)
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
Information contained in a prospectus

The minimum amount of investment required

The investment objective

The return on the fund over the past year, the past
three years, and the past five years

The exposure of the fund to various types of risk

The services offered by the fund

The fees incurred by the find that are passed on to
investors
Background on Mutual Funds
(cont’d)
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
Estimating the net asset value

The net asset value (NAV) of a mutual fund indicates
the value per share

Estimated each day by determining the market value of all
securities comprising the fund, adding interest or dividends,
and subtracting expenses, then dividing by the number of


Mutual fund share price appreciation

Mutual fund classifications

Stock mutual funds, bond mutual funds, or money
market mutual funds (see next slide)
Background on Mutual Funds
(cont’d)
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Background on Mutual Funds
(cont’d)
Distribution of Investment in Mutual Funds
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
Expenses incurred by shareholders

Mutual funds pass their expenses on to their
shareholders

Expenses can be compared among mutual funds by
comparing the expense ratio

Equal to annual expenses per share divided by the NAV

The higher the expense ratio, the lower the return for a given
level of performance

Mutual funds with lower expense ratios tend to outperform
others with similar objectives

between the bid and ask prices of the load fund

Front-end load versus back-end load
Background on Mutual Funds
(cont’d)
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
Sales load (cont’d)

No-load funds are promoted strictly by the mutual
fund of concern

Preferred by investors who feel capable of making their own
investment decisions

Recently, some small no-load funds have become load
funds because they could not attract sufficient investors
Background on Mutual Funds
(cont’d)
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12b-1 fees:

Were allowed in 1980 as distribution fees

Have sometimes been used by funds to pay a
commission to a broker whose clients invested in the
fund

May be charged instead or in addition to loads

The primary objective is to increase investment value

Capital appreciation funds are composed of stocks that
have high growth potential but may be unproven

Suited to investors who are willing to risk a possible loss in
value

Growth and income funds provide potential for capital
appreciation with some stability in income
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Stock Mutual Fund Categories
(cont’d)

International and global funds

International funds invest in 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
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Stock Mutual Fund Categories
(cont’d)

Specialty funds focus on a group of companies
sharing a particular characteristic
