1. Securities Firms (I) (ch23) – BUS322 1 Securities Firms Mutual Funds Overview –Mutual Funds Basics –Performance Evaluations –Hedge Funds Underwriting Brokerage Service

2. Securities Firms (I) (ch23) – BUS322 2 Overview of Securities Firms’ Business –Investment Banking Business –Brokage Service –Investment Funds — Mutual Funds — Hedge Funds

3. Securities Firms (I) (ch23) – BUS322 3 Mutual Fund Overview Management/investment company –e.g., Fidelity Management and Research Corporation, a subsidiary of Fidelity Investments –Providing investment advice Mutual Funds independent directors –Have independent directors –Transfer agent (servicing existing fund shareholders) –Underwriter/distributor (selling funds) –Fund Managers Fund brokers Fund custodians

4. Securities Firms (I) (ch23) – BUS322 4 Fund Types Open-end funds versus close-end funds Open-end Fund: shares can be redeemed at any time at a price that is tied to the asset value of the fund (net asset value, abbreviated as NAV). When we talk about mutual fund, we usually refer to open end fund Closed-end fund: a fixed number of nonredeemable shares are sold at an initial offering and then traded in OTC market like a common stock. Price of share could be different from NAV. UIT Exchange-traded funds.

5. Securities Firms (I) (ch23) – BUS322 5 Fund Types Based on investment objectives (way to create peer group) –Morningstar has 48 categories (Morningstar StyleMap) –Lipper has 91 categories (Lipper Style box classification) –Means to compare fund performance — Is a fund necessarily good if it consistently outperforms S&P 500 for 5 years?

6. Securities Firms (I) (ch23) – BUS322 6 Mutual Fund Types Balanced Funds Bond Funds Value Funds – low P/E, P/B, M/B ratio Growth Funds – high growth, P/E, P/B, M/B Growth and Income Funds – high Div payout Index Funds – low fee, diversified - exchange traded funds (ETFs) Money Market Mutual Funds – low risk, high liquidity - T Rowe Price Associate

7. Securities Firms (I) (ch23) – BUS322 7 Fee Structure No-Load Funds funds without sales commissions/front-end charges Load Funds funds with sales commissions/front-end charges

8. Securities Firms (I) (ch23) – BUS322 8 Fees in addition to Front loads Back-end load/Redemption fee/deferred load –Contingent deferred sales charge (CDSC) 12b-1 fee –Covering distribution costs, advertising and marketing expense, limited to 1% per year Operating expense –Costs incurred in operating the portfolio, measured by expense ratio (0.2-2%) — Management fee — 12b-1 fees Exchange fee Account maintenance fee

9. Securities Firms (I) (ch23) – BUS322 9 Fund Classes Funds from alternative classes have the same portfolio of securities but impose different combination of fees. Investors select the best combination of fees Class A shares sold with front-end loads of 4%-5%, no 12b-1 fee Class B shares impose 12b-1 charges and back-end loads Class C shares don’t impose back-end redemption fees, but have 12b-1 fees higher than those in class B (1%) Class D shares include front end loads and 12-1 charges of 0.25% Class I shares: institutional shares (no front-end charge and low annual operating expense) Fee and loads contingent on scale of investment –Breakpoint: Dollar levels of investment in a fund that qualify you for reduced sales charges.

10. Securities Firms (I) (ch23) – BUS322 10 Break Points Class A shares have a front-end load 8.5% while decrease depending on the amount of money you initially invest –0 – 9,999 8.5% –10,000 – 24,999 7.75% –25,000 - 49,999 6.25% –50,000 – 99,999 4.00% –100,000 – and up 0.00%

11. Securities Firms (I) (ch23) – BUS322 11 Disclosure Requirement Funds are registered with SEC, providing Prospectus: (1) objective (2) fees and expenses (3) investment strategy and risk (4) how to buy and sell Shareholder Report (1) fund performance (2) fund financial statement (3) required to report semiannually

12. Securities Firms (I) (ch23) – BUS322 12 Calculating Mutual Fund Return Net Asset Value (NAV) Total value of the mutual fund’s stocks, bonds, cash, and other assets minus any liabilities such as accrued fees, divided by the number of shares outstanding. Return

13. Securities Firms (I) (ch23) – BUS322 13 Fund NAV and Return Stocks$35,000,000 Bonds$15,000,000 Cash $3,000,000 Total value of assets$53,000,000 Liabilities -$800,000 Net worth $52,200,000 Outstanding shares 15 million NAV =

14. Securities Firms (I) (ch23) – BUS322 14 Now suppose value of stocks increases to $40 million, and that of bonds increases to 20 million, while other things being equal what is new NAV? What is return of the fund? Stocks Bonds Cash total value of assets liabilities net worth shares

15. Securities Firms (I) (ch23) – BUS322 15 Performance measures Sharpe ratio: Treynor measure: Jensen measure:

16. Securities Firms (I) (ch23) – BUS322 16 Hedge Funds 1. Take advantage of unusual spreads between security prices Long undervalued securities, short overvalued securities Market-neutral investment 2. Often highly leveraged –Using leverage to increase ROE 3. Strong managerial incentive –Fund managers receive 1% annual management fee, 14% annual profit when fund return exceeds “high water mark” 4. Relatively unregulated –Domestic hedge fund (fewer than 100 investors, limited partnership) –Offershore hedge funds (non-U.S. corporations), not subject to SEC regulations

17. Securities Firms (I) (ch23) – BUS322 17

18. Securities Firms (I) (ch23) – BUS322 18 Investment Banking Investment banks’ major responsibility is to assist in the initial sale of securities in the primary market, namely, underwriting stocks and bonds –Include both IPOs and seasoned offers Glass-Steagall Act separates commercial banking from investment banking

19. Securities Firms (I) (ch23) – BUS322 19 Underwriting Stocks and Bonds Giving Advice When to offer? At what price? Filing Documents SEC Registration statement Prospectus Underwriting Syndicate Tombstones Marketing Outcomes Fully subscribed Undersubscribed Oversubscribed Best Efforts

20. Securities Firms (I) (ch23) – BUS322 20 Ten Largest Underwriters in the U.S.

21. Securities Firms (I) (ch23) – BUS322 21 Other Investment Banking Service Private Placement Mergers and Acquisitions –Active in this market since 1960s –Serves both acquirers and target firms

22. Securities Firms (I) (ch23) – BUS322 22 Securities Brokers and Dealers Brokerage Service a. Securities Orders Market Order Limit Order – buy with maximum acceptable price and sell with minimum price short sell b. Other Services Margin Credit brokage-based cash management account c. Full-Service Brokers – provide research and investment advice d. Discount Brokers – execute trades on request Securities Dealers Market Makers – increase market liquidity

23. Securities Firms (I) (ch23) – BUS322 23 Box 1: Using the Limit-Order Book Unfiled Circuit City Limit Orders __________________________________ Buy OrdersSell Orders 37 100 37.125 300 37.25 100 37.375 200 37.50 500 37.625 100 Any deal now?

24. Securities Firms (I) (ch23) – BUS322 24 Orders 1. 200-share market buy order 2. 300-share limit sell order at 37.125 3. 500-share limit buy order at 36.875 The order book is:

25. Securities Firms (I) (ch23) – BUS322 25 Short-selling – borrow shares Joel shorts 200 shares of IBM stocks at $50/share. Later on the stock price goes to $40/share. How much profit/loss Joel has made in this transaction?

26. Securities Firms (I) (ch23) – BUS322 26 Buy-on-margin – borrow money Amy bought 10,000 shares of IBM stocks at $50/shares with her margin account. The IBM price increases to $60 later. How much profits/losses Amy could make?