1. Chapter 7 – Investment Companies BA 543 Financial Markets and Institutions

2. Chapter 7 – Investment Companies Indirect Investing Shares of investment company fund represent proportional ownership in portfolio Investment company is the listed owner of the shares of the portfolio Investors in the company fund are the beneficiary owners of the shares of the portfolio Benefit -- Professional Management of Funds Shared costs across investors Diversification at a low cost

3. Chapter 7 – Investment Companies Open-End Funds Number of shares vary based on purchases and sales of shares by owners Company acts as the “broker” of all shares Closed-End Funds Limited number of shares from charter Shares trade in secondary market after initial sale Unit Trust Bond Portfolio – Related to Closed-End Fund Bonds held to maturity (exceptions for quality change) Fixed termination date Common in Europe but not U.S.

4. Chapter 7 – Investment Companies Net Asset Value (NAV) Price of the shares of the investment company fund NAV = (Value of Portfolio – Liabilities) / Shares Price fixed once daily at close of business Trading in shares for open-end Purchases and sales by investment company Price is the NAV (minus load) at end of day Examples of Trading Costs (Sales Charge) No Load – no charge, costs in operating charges Front-end Load (max is 8.5%, typical 2% - 3%) Back-end or Contingent Deferred Sales Charge

5. Chapter 7 – Investment Companies Annual Operating Expenses (Expense Ratio) Services for Members Management fees Distribution fees for marketing, agent compensation and advertising (12b-1 fees, max is 1% of portfolio value) Other fees (accounting, custodial, legal, directors, etc.) No-Loads cannot charge 12b-1 fees Why so popular? Provide diversification, lower contracting costs, professional management, liquidity, payment mechanisms

6. Chapter 7 – Investment Companies Taxing Mutual Funds Regulated Investment Company (RIC) must distribute 90% of investment income Taxes not paid at the “fund” Taxes paid at the individual level on distributions Investors may “automatically” reinvest distributions but still incur tax obligation Capital Gains distributions Occur typically late in year Based on transactions that year All shares are “taxed” regardless of holding period

7. Chapter 7 – Exchange Traded Funds Do it yourself mutual funds These are ticker symbol “stocks” that match an index and function like a closed-end fund Trade throughout the day at “current” index price Limit or market orders, stop-loss orders, shorted Have options trading on them Arbitrageur keeps prices aligned between “stock” and underlying portfolio (aka authorized participants) and create and redeem units First ETF was S&P 500 and symbol is SPY As of 2007 – 629 ETFs