Lesson 3: Financial Services: Mutual and Hedge Funds Pt2 Flashcards
A mutual fund owns 300 shares of General Electric, currently trading at $30, and 400 shares of Microsoft Inc., currently trading at $54. The fund has 1,000 shares outstanding.
a. What is the net asset value (NAV) of the fund?
NAV = (300 x $30 + 400 x $54)/1,000 = $30,600/1,000 = $30.60.
A mutual fund owns 300 shares of General Electric, currently trading at $30, and 400 shares of Microsoft Inc., currently trading at $54. The fund has 1,000 shares outstanding.
b. If investors expect the price of General Electric shares to increase to $34 and the price of Microsoft shares to decrease to $48 by the end of the year, what is the expected NAV at the end of the year?
Expected NAV = (300 x $34 + 400 x $48)/1,000 = $29,400/1,000 = $29.4, or a decline of 3.92%
A mutual fund owns 300 shares of General Electric, currently trading at $30, and 400 shares of Microsoft Inc., currently trading at $54. The fund has 1,000 shares outstanding.
c. Assume that the expected price of the General Electric shares is realised at $34. What is the maximum price decreasethat can occur to the Microsoft shares to realise an end-of-year NAV equal to the NAV estimated in part a?
(Answer to part a: NAV = $30.60)
[(300 x $34) + (400 x PM)]/1,000 = $30.60, implies that PM = $51.00, a decrease of $3.00
What is the difference between open-end and closed-end mutual funds?
Which type of fund tends to be more specialised in asset selection?
How does a closed-end fund provide another source of return from which an investor may either gain or lose?
Open-end funds allow shares to be purchased and redeemed according to investor demand. The NAV of open-ended funds is determined only by changes in the value of the assets owned.
In closed-end funds, the number of shares of the fund is fixed. If investors need to redeem their shares, they sell them to another investor. Thus, the demand for the fund shares can provide another source of return for the investors as the market price of the fund may exceed the NAV of the fund. Closed-end funds, such as real estate investment trusts, tend to be more specialised.
Open-end fund A owns 165 shares of AT&T valued at $35 each and 30 shares of Toro valued at $75 each. Closed-end fund B owns 75 shares of AT&T and 72 shares of Toro. Each fund has 1,000 shares of stock outstanding.
a. What are the NAVs of both funds using these prices?
NAVopen-end = (165 x $35 + 30 x $75)/1,000 = $8.025 NAVclosed-end = (75 x $35 + 72 x $75)/1,000 = $8.025
Open-end fund A owns 165 shares of AT&T valued at $35 each and 30 shares of Toro valued at $75 each. Closed-end fund B owns 75 shares of AT&T and 72 shares of Toro. Each fund has 1,000 shares of stock outstanding.
b. Assume that in one month the price of AT&T stock has increased to $36.25 and the price of Toro stock has decreased to $72.292. How do these changes impact the NAV of both funds?
If the funds were purchased at the NAV prices in part (a) and sold at month end, what would be the realised returns on the investments?
(NAV Prices in part a: NAV open-end: $8.025
NAV closed-end: $8.025)
NAVopen-end = (165 x $36.25 + 30 x $72.292)/1,000 = $8.150
Percentage change in NAV = ($8.150 - $8.025)/$8.025 = 1.56%
NAVclosed-end = (75 x $36.25 + 72 x $72.292)/1,000 = $7.923774
Percentage change in NAV = ($7.923774 - $8.025)/$8.025 = -1.26%
Open-end fund A owns 165 shares of AT&T valued at $35 each and 30 shares of Toro valued at $75 each. Closed-end fund B owns 75 shares of AT&T and 72 shares of Toro. Each fund has 1,000 shares of stock outstanding.
c. Assume that another 155 shares of AT&T are added to fund A. The funds needed to buy the new shares are obtained by selling 676 more shares in fund A. What is the effecton fund A’s NAV if the stock prices remain unchanged from the original prices?
NAVopen-end = ((165 + 155) x $35 + 30 x $75)/(1,000 + 676) = $8.025.
Percentage change in NAV = ($8.025 - $8.025)/$8.025 = 0.00%.
What is a hedge fund and how is it different from a mutual fund? (pt1)
Hedge funds are a type of investment pool that solicits funds from (wealthy) individuals and other investors (e.g., commercial banks) and invests these funds on
their behalf. Hedge funds are similar to mutual funds in that they are pooled investment vehicles that accept investors’ money and generally invest it on a collective basis.
Hedge funds are, however, not subject to the numerous regulations that apply to mutual funds for the protection of individuals, such as
• regulations requiring a certain degree of liquidity
•regulations requiring that mutual fund shares be redeemable at any time
•regulations protecting against conflicts of interest
•regulations to ensure fairness in the pricing of funds shares
•disclosure regulations; and
•regulations limiting the use of leverage.
Further, hedge funds do not have to disclose their full activities to third parties.Thus, they offer a high degree of privacy for their investors.
What is a hedge fund and how is it different from a mutual fund? (pt2)
Historically, hedge funds avoided regulations by limiting the number of investors to less than 100 individuals, who must be deemed “accredited investors”. To be accredited, an investor must have a net worth of over $1 million or have an annual income of at least
$200,000 ($300,000 if married). These stiff financial requirements allowed hedge funds to avoid regulation under the theory that individuals with such wealth should be able to evaluate the risk and return on their investments.
Because hedge funds have been exempt from many of the rules and regulations governing mutual funds, they can use aggressive strategies that are unavailable to mutual funds, including: •short selling •leveraging •programme trading •arbitrage; and •derivatives trading
