ࡱ> FHEq` ^<bjbjqPqP ;x::4B$$$8H$$d9F<%6r&"&&&o'o'o'@9B9B9B9B9B9B9$<ho>f9o'o'o'o'o'f9&&{9---o'&&@9-o'@9--r|7TX8&0% $))B7@99097z>k*>X8>X8o'o'-o'o'o'o'o'f9f9=,o'o'o'9o'o'o'o'd$$ SOLUTIONS MANUAL CHAPTER 18 MUTUAL FUNDS Answers to Text Discussion Questions 1. Do mutual funds, on average, outperform the market? 18-1. Mutual funds, on average, do no better than the Standard & Poor's 500 Stock Index, the Dow Jones Industrial Average, etc. Some instructors, however, may choose to add that a few funds in the international area have had exceptional returns, partly because of the falling dollar exchange rate. 2. Do mutual funds generally provide efficient diversification? 18-2. Yes. This is perhaps the best attribute a mutual fund has. 3. Explain why the vast array of mutual funds available to the investor may be a partial drawback and not always an advantage. 18-3. The investor has so many mutual funds to choose from it may be as hard to select a mutual fund as it is a stock. 4. What is the basic difference between a closed-end fund and an open-end fund? 18-4. In a closed-end fund, there is a fixed number of shares and purchasers and sellers of shares must deal through each other, rather than with the fund. With an open-end arrangement, the fund stands ready at all times to sell new shares or buy back old shares. The number of shares is open-ended. 5. Define net asset value. Do closed-end funds normally trade at their net asset value? What about open-end funds? 18-5. The net asset value is equal to the current value of the securities owned by the fund minus any liabilities divided by the number of shares outstanding. Closed-end funds usually trade at a discount or a premium in relation to their net asset value (the discount is the more likely case). Open-end funds trade at their net asset value subject to any commissions. 6. Is it mandatory that you pay a load fee when purchasing an open-end mutual fund? What is a low-load fund? 18-6. No, many open-end funds have no load or commission. A low-load fund is one that charges 2 to 3 percent in comparison to the normal fee of 7.25 percent and more. 7. Should you get better performance from a load fund in comparison to a no-load fund? 18-7. No, research evidence indicates one is not necessarily superior to the other in terms of performance. 8. If there is a difference between the net asset value (NAV) and the offer price for a mutual fund, what does that tell us about the fund? 18-8. That it is a load mutual fund. 9. How can you distinguish between regular growth funds and aggressive growth funds? 18-9. Aggressive growth funds concentrate on speculative issues, emerging small companies and "hot" sectors of the economy, and frequently use financial leverage to magnify their returns. Regular growth funds generally invest in common stocks of more stable firms. 10. What type of fund is likely to invest in convertible securities? 18-10. A balanced fund is likely to invest in convertible securities. 11. Why might there be some potential danger in investing in sector funds? 18-11. An initial offering of sector funds usually occurs after the sector has been the subject of intense interest based on recent spectacular performance. As a result, stocks in that sector are probably fully priced or overpriced. These funds also provide less diversification. 12. What does Rule 12b-1 enable mutual funds to do? Is this normally beneficial to current mutual fund shareholders? 18-12. Rule 12b-1 allows mutual funds to use fund assets for marketing purposes. Since marketing expenses have nothing to do with advancing shareholder's interests and everything to do with increasing the manager's fees, investors should be alert to this in the prospectus. 13. Are earnings of mutual funds normally taxed at the fund level or the shareholder level? 18-13. Mutual fund earnings are normally taxed at the shareholder level. A fund that distributes at least 90 percent of its net investment income and capital gains is not subject, as an entity, to federal income taxes. It simply acts as a "conduit" in channeling taxable sources of income from securities held in the portfolio to the fund's shareholders. 14. What is the advantage of investing in a mutual fund that offers an exchange privilege? 18-14. Within certain limits, shareholders are free to move their money between the different funds in the family of funds on a net asset value basis. Only a minimal charge is common to cover paperwork. 15. What is dollar-cost averaging? If you were a particularly astute investor at timing moves in the market, would you want to use dollar-cost averaging? 18-15. With dollar-cost averaging, the investor buys a fixed dollar's worth of a given security at regular intervals regardless of the security's price or the current market outlook. If you are a successful market timer, you would not want to use dollar-cost averaging. 16. From the viewpoint of an individual investor, what is the potential tax disadvantage of investing in a mutual fund? You cannot control the timing of when to take a loss or gain on a mutual fund like you can when you own an individual stock. Furthermore, in a bull market you may buy into a fund that has previously accumulated gains for which you will be taxed even though you were not a fund holder at the time of the gain. PROBLEMS Net asset value 1. The Twenty-First Century closed-end fund has $350 million in securities, $8 million in liabilities, and 20 million shares outstanding. It trades at a 10 percent discount from net asset value (NAV). a. What is the net asset value of the fund? b. What is the current price of the fund? c. Suggest two reasons why the fund may be trading at a discount from net asset value. 18-1. a)  EMBED Equation.DSMT4  b)  EMBED Equation.DSMT4  c) A fund may trade at a discount because of a poor record of prior performance or because of heavy investments in an unpopular industry. Net asset value 2. The New Pioneer closed-end fund has $520 million in securities, $5 million in liabilities, and 10 million shares outstanding. It trades at a 5 percent premium above its net asset value (NAV). a. What is the net asset value of the fund? b. What is the current price of the fund? c. Why might a fund trade at a premium above its net asset value? 18-2. a)  EMBED Equation.DSMT4  b)  EMBED Equation.DSMT4  c) A fund may trade at a premium because of the quality of management, the nature of its investments, or the fact that it has holdings in unlisted securities or securities of private companies that are believed to be undervalued on its books. Load funds 3. In problem 2, if New Pioneer converted to an open-end fund trading at its net asset value with a 6 percent load (commission), what would its purchase price be? 18-3.  EMBED Equation.DSMT4  Load vs. no-load 4. In problem 2, if New Pioneer converted to an open-end fund and traded at $51.50, would it be a load or no-load fund? 18-4. Since the fund is trading at its net asset value of $51.50 (as computed in Problem 2), it is a no-load fund. Load funds 5. An open-end fund is set up to charge a load. Its net asset value is $8.72, and its offer price is $9.25. a. What is the dollar value of the load (commission)? b. What percentage of the offer price does the load represent? c. What percentage of the net asset value does the load represent? d. Do load funds necessarily outperform no-load funds? e. How do no-load funds earn a return if they do not charge a commission? 18-5. a)  EMBED Equation.DSMT4  b)  EMBED Equation.DSMT4  c)  EMBED Equation.DSMT4  d) There is no evidence of superior performance e) Through a management fee (plus expenses) that normally equals about .75 to 1.25 percent of the assets managed. Load funds have similar fee structures. Load funds 6. In problem 5, assume the fund increased in value by $0.30 the first month after you purchased 300 shares. a. What is your total dollar gain or loss? (Compare the total current value with the total purchase amount.) b. By what percentage would the net asset value of the shares have to increase for you to break even? 18-6. a)  EMBED Equation.DSMT4  b) You must earn the load of $.53 on the net asset value of $8.72. The answer is 6.08 percent. This is the same as the answer to 18-5 (c).  EMBED Equation.DSMT4  Comparative fund performance and loads 7. a. If you purchased a low-load fund at $10.30 and it had a net asset value of $10.00, what is the percent load? b. If the funds net asset value went up by 33.72 percent, what would its new net asset value be? c. What is your dollar profit or loss per share based on your purchase price? d. What is your percentage return on your purchase price? 18-7. a)  EMBED Equation.DSMT4  b) Old net asset value $10.00 Gain (1+.3372) 1.337 New net asset value $13.37 c) New net asset value $13.37 Purchase price 10.30 Profit $ 3.07 d)  EMBED Equation.DSMT4  Total returns on a fund 8. An investor buys Go-Go Mutual Fund on January 1 at a net asset value of $21.20. At the end of the year, the price is $25.40. Also, the investor receives $0.50 in dividends and $0.35 in capital gains distributions. What is the total percent return on the beginning net asset value? (Round to two places to the right of the decimal point.) 18-8. Beginning NAV $21.20 Ending NAV 25.40 Change in NAV (+) $ 4.20 Dividends distributed .50 Capital gains distributed .35 Total return $5.05  EMBED Equation.DSMT4  Total returns on a fund 9. Dan Herman purchases the Ivy Tower New Horizon Fund at a net asset value of $11.25. During the year, he receives $0.50 in dividends and $0.14 in capital gains distributions. At the end of the year, the funds price is $10.90. What is the total percentage return or loss on the beginning net asset value? (Round to two places to the right of the decimal point.) 18-9. Beginning NAV $11.25 Ending NAV 10.90 Change in NAV () .35 Dividends distributed .50 Capital gains distributed .14 Total Return .29  EMBED Equation.DSMT4  Total returns with reinvestment 10. Alice Olivia had 200 shares of the Quest Fund on January 1. The shares had a value of $17.60. During the year she received $90 in dividends and $270 in capital gains distributions. She used the funds to purchase shares at an average price of $18 per share. By the end of the year, the shares were up to $18.50. What is her percentage total return? Use Formula 182 and round to two places to the right of the decimal point. Recall you first must determine the number of new shares. 18-10. Step 1 Number of new shares = (Dividends + Capital gains)/Share price = ($90 + $270)/$18 = $360/$18 = 20 New shares Step 2  EMBED Equation.DSMT4  Total returns with reinvestment 11. Tom Aaron had 300 shares of the New Decade Fund on January 1. The shares had a value of $23. During the year he received $150 in dividends and $450 in capital gains distributions. He used the funds to purchase shares at an average price of $25 per share. By the end of the year, the shares were all up to $27. What is the percentage of his total return? Use Formula 182 and round to two places to the right of the decimal point. Recall that you first must determine the number of new shares. 18-11. Step 1 Number of new shares = (Dividends + Capital gains)/Share price = ($150 + $450)/ $25 = $600/$25 = 24 new shares Step 2  EMBED Equation.DSMT4  Dollar-cost averaging 12. Under dollar-cost averaging, an investor will purchase $6,000 worth of stock each year for three years. The stock price is $40 in year 1, $30 in year 2, and $48 in year 3. a. Compute the average price per share. b. Compute the average cost per share. c. Explain why the average cost is less than the average price. 18-12. Year Investment Share Price Share Purchased 1 $ 6,000 $ 40 150 2 6,000 30 200 3 6,000 48 125 Totals $18,000 $118 475 a) Average price = $118/3 = $39.33 b) Average Cost =  EMBED Equation.DSMT4  c) The average cost is less than the average price because more shares were purchased at lower costs (based on the fixed dollar investment). Chapter 18 Solution to Investment Advisor Problem Tony should make Lou aware that a majority of mutual funds do not charge any commission. Chances are if Lou goes to Morningstar.com, Forbes Magazine or other sources, he can find a mutual fund with a similar record of performance that is a no-load (no commission) fund. It also may not have an exit (sales) fee. Furthermore, Tony should point out to Lou that past record of performance is no assurance of future performance. Some funds have a strategy that works well in one market environment but will not provide a similar return in a different market environment. Such might be the case with this fund with its aggressive growth strategy and 16.6 percent return over the last 10 years. The number is impressive, but far from guaranteed. The Breakeven point is: $36 Mutual fund price 3% Percent Commission $1.08 Dollar Commission Actual investment in shares ($36 - $1.08) = $34.92 Dollar commission $1.08 / Investment of $34.92 = 3.09% 3.09% is the amount the mutual fund shares must go up in value to put Lou at the breakeven point.     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