1. 4. Mutual Funds, Investment Dealers, and Other FIs
Two types of mutual funds:
Closed-End Funds
Open-End Funds
4.1 Closed-End funds
Sold at an exchange or Over-the-counter
Price can sell at a premium or discount to the mark-to-market value of the underlying securities.
Closed-End fund puzzle is that the shares usually sell at a discount. Agency costs, tax liabilities, and illiquidity of assets do not explain 1

2. 4.2 Open End Funds
Number of shares vary depending on purchases and redemptions
Shareholders redeem at the current Net Asset Value (NAV)
Two types of funds: Retail and institutional
Large selection of funds: Balanced, Money Market, Growth, Industrial, Index.
Research shows open-end funds underperform other similar investment vehicles. Much of this is explained by the fees charged.
Enormous growth. By 1996, 21.2% of market is owned by stock mutual funds compared to 7% in 1987. 1

3. 4.3 Open End Funds--Pricing
Invest $2500 into a Growth Mutual Fund
Current Price is $10/unit
You purchase 250 units
Annual Return is 10%, what is the price per unit?
How much would you receive in cash?
What would happen to NAV if there was a 3% management fee? 1

4. 4.4 Fees Charged by Open End Funds
Load fees (Front and back-end loads) and Share classes
Management fees
Administrative
12b1 fees (Trailer fees)
Fee Waivers
Soft-dollars
Capital gains taxes and the affect on investment
What are the net returns reported on your mutual fund statement?
What are the expense ratios reported in a prospectus?
What is the 10% free rule? 1

5. Financing B shares Limited partnership LP Mutual Fund Broker Investors
Initial and Trailing Commission
Fixed Price LP
Mutual Fund
Broker
Loads and fixed %NAV
Loads & 12b1
Investors
Tax Arbitrage?

6. Financing B shares Securitization SPV Mutual Fund Broker Investors
Initial and Trailing Commission
Fixed Price
SPV
Mutual Fund
Broker
Loads and fixed %NAV
Fixed Income Security
Loads & 12b1
Investors
Investors
Tax Arbitrage?

7. 4.5 Money Market Funds
Restricted to holding assets with maturities less than 270 days
Very liquid
Grew enormously during the 1970s and 1980s by attracting depositors away from banks
Accounting rules allow money market funds to report book values rather than market values because the durations are short. These are the only funds allowed to do this. Net Asset Value is always $1 per share but the dividends can change
What does it mean to break-the-buck? 1

8. 4.6 Manager’s Incentives
How could a company like Steadman charge expenses of 20%? 1

9. 4.7 Manager’s Incentives
Performance and Asset Growth in Money Market Funds 1

10. 4.7 Manager’s Incentives
Performance and Fee Waiving in Money Market Funds 1

11. 4.8 Issues raised on mutual funds
Does the transfer from institutional investors to individual investors through mutual funds create market instability?
Are management fees too high?
Are mutual funds getting too big to invest in the market?
Why are investors slow to leave poor performing funds?
Should management fees be visible on statements?
What conflicts of interest could arise between the fund manager and the unit holder? 1

12. 4.9 Investment Dealers
Several tasks performed by Investment Dealers. Two broad areas
1. Customer Services
2. Market Transactions and Services
1. CUSTOMER SERVICES INCLUDE:
Retail Brokerage (Discount and Full-Service)
Wholesale Brokerage 1

13. 4.9 Investment Dealers 2. MARKET SERVICES INCLUDE: Investment Banks
Private Placements
Underwriting a Public Offering (IPO)
Primary Market of debt, equity, and derivatives
Best Efforts versus full underwriting
Merger and Acquisition advisors
Merchant Banks and Mezzanine Financing
Market Makers and Designated Jobber (Secondary Market)
Investing for investors or for themselves
Trading -- position, pure arbitrage, risk arbitrage, program
Back-office 1

14. 4.10 Investment Dealers: Regulation and Trends
Liquid Balance sheet
Liabilities include short-term REPOs and short positions of assets
Self-regulatory organisations: IDA, stock exchanges,
OSC by its size has evolved as the federal regulator: licenses, monitors, reviews prospectuses and investigates violations
CIPF Canadian Investor Protection Fund 1

15. 4.11 Questions on Investment Dealers
What is the difference between a merchant bank and an investment bank?
What is the risk to an investment broker that builds up its inventory of long-term bonds but funds it in the short-term market (REPOs)?
Why is risk arbitrage not riskless?
Is high stock volatility good or bad for investment dealers?
How does the reorganization of the exchanges get around problems facing Canadian Investment Dealers?
What differences in culture between banks and investment dealers would make integrating these two cultures difficult? 1

16. 4.12 Financing Institutions
Leasing Company
Government Companies
Canada Mortgage and Housing Corporation
Export Development Corporation
Farm Credit Corporation
Business Development Bank of Canada
How do these institutions differ from a bank? From an investment dealer?
Do you think leasing companies supported the proposed bank mergers? 1

17. 4.13 Summary
Mutual funds bear little to no risk (except for expense costs). Instead the investor bears the risk of market fluctuations. The only mutual fund which is exposed to some risk from asset price fluctuations are money market funds.
Investment Dealers are the main financial institution in the primary market
Mutual funds compete with banks for demand deposits
Financing Companies compete with banks for loans 1

18. 4.14 Websites www.osc.gov.on.ca www.sec.gov www.sedar.com www.tse.com 1