Fin 325 CHPT 3 & 4

What do the terms "open-end" and "closed-end" mean in regards to a firm's capitalization?

"Open-end" means that the number of shares of the mutual fund outstanding is not fixed. Rather, the number of shares (and firm capitalization) varies daily as investors buy shares from the mutual fund company and redeem shares back to the mutual fund company. In contrast, shares outstanding remain constant for closed-end funds unless the firm issues additional shares or repurchases shares.

What does it mean for a firm to be regulated?

A regulated investment company can elect to pay no federal taxes by "flowing through" distributions of dividends, interest, and realized capital gains to shareholders who pay their own marginal tax rates on these distributions.

What are the direct and indirect ways in which mutuals funds are typically purchased?

Mutual fund shares are typically purchased directly from the investment company that operates the fund. The investor contacts the company, obtains a prospectus and application, and buys and sells shares by mail or phone. Alternatively, mutual funds can be purchased indirectly from a sales agent, including securities firms, banks, life insurance companies, and financial planners. Mutual funds may be affiliated with an "underwriter," which usually has an exclusive right to distribute shares to investors. Most underwriters distribute shares through broker/dealer firms.

Explain the difference between NASD and NASDAQ

NASD stands for the National Association of Security Dealers, a self- regulating body of brokers and dealers that oversees Nasdaq and OTC practices. NASD licensed brokers and handled the punishment for violators of its prescribed fair practices. The NASD merged with the New York Stock Exchange's regulation committee in 2007, resulting in the Financial Industry Regulatory Authority, or FINRA. Nasdaq is an electronic screen-based equity securities market providing instantaneous transactions as market makers compete for investor orders.

What is meant by the exchange privilege within a family of funds?

Once an investor buys a particular fund within an investment company, such as Vanguard or Fidelity, he or she can easily sell the shares of that fund and purchase shares of another fund within the same organization.

What are open-end companies?

Open-end investment companies (mutual funds) continually sell and redeem their shares, based on investor demands. Share-owners deal directly with the company.

What are passively managed country funds?

Passively managed country funds are geared to match a major stock index of a particular country (e.g. the Japan fund). Each of these offerings will typically be almost fully invested, have little turnover, and offer significantly reduced expenses to shareholders.

As an investor with a broad portfolio of stocks, would you rather see the S&P 500 index and DIJA perform similarly or differently over some period of time?

Presumably, if you owned a portfolio of large cap stocks, you would prefer to see both indexes moving in a similar manner, which would then be more reassuring as to how your own portfolio was performing. On the other hand, if you owned a portfolio of small and mid-cap stocks, you would probably prefer to see the S&P doing better because it might be more closely reflecting the performance of such stocks. The DJIA will reflect the performance of the large stocks in that index.

what is the Dow Jones Industrial Average? how does it differ from the S&P 500 composite index?

4-15. The Dow-Jones Industrial Average is a price-weighted average of 30 large (blue chip stocks) trading on the NYSE. The S&P 500 Composite Index is a market value index consisting of 500 stocks, with a base period set to 10 (1941-1943). These measures are the two most often-used indicators of what stocks in general are doing. The Dow-Jones Averages are supported by The Wall Street Journal, while the S&P 500 Index is the indicator most often used by institutional investors.

Why might a closed end fund be worth more dead than alive?

A closed-end fund selling at a discount is technically worth more dead than alive in the sense that if investors could take over the fund, they could liquidate the portfolio and enjoy a gain. Think of a closed-end selling at a 20 percent discount. If assets could be bought for $0.80 on the dollar and liquidated at face value, in principle a nice gain could be realized. Of course, attempts to take over a fund would likely drive the price up and reduce some, or all, of the potential gain.

What is a fund supermarket?

A fund supermarket is a mechanism by which investors can buy, own and sell the funds of various mutual fund families through one source, such as a brokerage firm. "Supermarket" refers to the fact that an investor has hundreds of choices available through one source.

What is an MMF?

A money market fund is an investment company formed to invest in a portfolio of short-term, highly liquid, low risk money market instruments. Interest is earned daily, and shares can be sold at any time. There are no sales commissions or redemption fees. Most money market mutual funds hold a substantial part of their assets in the form of Treasury bills because of their safety and liquidity. In effect, these funds are doing for investors what they could do for themselves if they had enough funds to purchase Treasury bills and earn the going risk-free rate of return directly.

is there any similarity between an NASDAQ market maker and a designated mart maker on an exchange?

A specialist on the exchange often acts as a dealer, buying and selling for his or her own account. Nasdaq market makers may do the same thing.

Differences between Value fund and growth fund?

A value fund generally seeks to find stocks that are cheap on the basis of standard fundamental analysis yardsticks, such as earnings, book value, and dividend yield. Growth funds, on the other hand, seek to find companies that are expected to show rapid future growth in earnings, even if current earnings are poor or, possibly, nonexistent.

In terms of how they are constructed, what are the two primary types of stock indexes currently being used in the US?

Almost all stock price indices today are market value weighted indexes, or capitalization weighted. The exception is the DJIA, a price-weighted index. The price weighted procedure is a holdover from the 19th Century, when the Dow Jones Industrial Average was started. All price indexes created today are market-value weighted indexes.

What is meant by the statement, the bond market is primarily an OTC market?

Although a few bonds trade on the NYSE and ASE, the bond market is primarily an OTC market. All federal, agency, and municipal bonds trade OTC, and most corporates.

Explain what an ECN is

An ECN is an Electronic Communication Network. Basically, ECNs are fully computerized trading networks that match buy and sell orders from investors without the use of a dealer.

How are ETFs and CLosed end funds similar?

An ETF is quite similar to a closed-end fund in that both trade on exchanges and can be sold short and bought on margin.

What is an OTC security? How are such securities traded?

An OTC security is an unlisted security not trading on an exchange. Nasdaq trades listed securities, and in January 2006 was approved by the SEC to become an exchange. OTC securities typically involve very small, relatively unknown companies.

What does it mean to say that an index fund is related to indirect investing?

An index fund is a passive portfolio, holding the securities of some index. No active management decisions are made as to what to buy and sell, or when to buy and sell. Passive investing refers to making few if any decisions regarding the management of a portfolio. The investor holds some set or index of securities.

What is an investment company?

An investment company is a financial corporation organized for the purpose of investing in securities, based on specific objectives.

Why might one prefer ETF to open end funds?

An investor may prefer an ETF to a mutual fund because its shares can be bought and sold any time during the trading day. Shares can also be shorted, and bought on margin. The annual expense ratio is typically lower than that for a mutual fund. Finally, the ETF may be more tax efficient.

What are advantages to having an MMF?

Benefits of money market funds include: (a) current money market rates can be earned (b) securities with high minimum denominations, which most investors could not purchase, are held by these funds on behalf of shareholders (c) diversification (d) check-writing privileges--investors earn interest until the check actually clears (e) shares are quickly redeemable by wire (f) no sales charge or redemption charge (g) interest is earned and credited daily A disadvantage is that these funds are not insured. Of course, when money market rates are low, or close to zero as in recent years, these funds provide very little income.

Waht is meant by block aactivity on the NYSE? how important is it on the NYSE?

Blocks are defined as transactions involving at least 10,000 shares. Large-block activity on the NYSE is an indicator of institutional investor participation in equity trading. The total number of large-block transactions has become a prominent part of trading on the NYSE over the years.

What is meant by the term blue-chip stocks? examples?

Blue chip stocks are large, well-established and well-known companies with long records of earnings and dividends. They are typically traded on the NYSE. Examples include Coca-Cola, General Electric, and Exxon Mobil.

What are closed-end companies?

Closed-end investment companies have a fixed capitalization, and their shares trade on exchanges or over-the-counter.

In what ways is an investment banker similar to a commission broker?

Commission brokers are members of brokerage houses with memberships on exchanges. They act as brokers for customers. Investment bankers act as middlemen between the issuers of the securities and the purchasers, in the same way that brokers do. Some firms offer both investment banking and retail brokerage services.

how is the DIJA biased against growth stocks?

Growth stocks are the most likely stocks to split. As high-priced stocks split and their prices decline, they lose relative importance in the DJIA, which is a price-weighted series. High-price stocks carry more weight than do low-priced stocks in such a series.

What advantage do ECNs offer?

ECNs offer the possibility of very quick execution, low costs, trading after the exchanges are closed, and anonymity.

What percentage of equity mutual fund assets are accounted for by index equity mutual funds? Should a typical investor pay 75 or 100 basis points for and index equity mutual fund?

Equity index fund assets account for about 20 percent of total equity mutual fund assets. It makes little sense to pay 75 or 100 basis points for an equity index fund from a brokerage firm when one can be purchased with an annual expense ratio of less than 20 basis points. The portfolios are identical, such as the S&P 500 Index.

Describe the importance of financial markets to the United States. Can primary markets exist without secondary markets?

Financial markets are essential for both businesses and governments in raising capital to finance their operations. Both experience demands for funds that are not in balance with their actual funds on hand. Financial markets are absolutely essential to the functioning of our capitalistic economy. Technically, primary markets can exist without secondary markets since new securities can be sold to investors. For example, bonds could be sold to institutional investors to be held until they mature. However, investors would have difficulty reselling these securities if they needed to, and many would be discouraged from buying them because of this reason.

how does a hedge fund differ from a mutual fund?

Hedge funds are investment pools for wealthy investors, subject (traditionally) to little regulation. They are known for taking large risks in pursuit of large returns. They traditionally have invested in ways that most mutual funds cannot or do not, such as selling short or investing in less liquid investments. Furthermore, they often do not disclose as much information about their activities as do mutual funds. Mutual funds, in contrast, are subject to significant regulation under the Investment Company Act of 1940. They cannot engage in the same activities as hedge funds.

Outline the process for a primary offering of securities involving investment bankers

In a primary offering involving investment bankers, the potential issuer of the securities meets with an investment banking firm for advice on selling the new issue. In a negotiated bid arrangement, these two parties negotiate and work together on the issue. Subsequently, the investment bankers purchase the securities from the issuer, thereby assuming the risk involved in actually selling the securities. After all legal requirements have been met (e.g. the issue is registered with the SEC), the selling group sells the securities to the public via brokers who contact their customers about the issue.

Since the NYSE features a fully automated auction, why do you think it also features a physical auction as well?

In order to compete with ECNs, the NYSE acquired Archipelago, one of the original ECNs. The NYSE then began functioning as a hybrid market.

what is meant by in-house trading? whos likely to benefit from this activity?

In-house trading refers to internal trading by fund managers within one company without the use of a broker or an exchange. Traders agree to buy and sell in-house, or cross- trade, perhaps at the next closing price. Fidelity Investments operates an in-house trading system for its own funds because of the large amount of buying and selling it does every day. Large international investors will benefit from in-house trading.

Why do you think the first index fund was met with such hostility?

Index funds have no sales charges and very low expenses. Those in the industry did not want to see such funds competing with their other funds which might have much higher sales charges and management fees.

What is meant by indirect investing?

Indirect investing involves the purchase and sale of investment company shares. Since investment companies hold portfolios of securities, an investor owning investment company shares indirectly owns a pro-rata share of a portfolio of securities

What is the difference between a global fund and an international fund?

International funds concentrate on international stocks. In one recent year, Fidelity Overseas Fund was roughly one-third invested in Europe and one-third in the Pacific Basin, whereas Kemper International had roughly one-sixth of its assets in each of three areas, the United Kingdom, Germany, and Japan. On the other hand, global funds tend to keep a minimum of 25 percent of their assets in the United States. For example, in one recent year, Templeton World Fund had over 60 percent of its assets in the United States and small positions in Australia and Canada.

What are the functions of an investment banker?

Investment bankers act as intermediaries between issuers and investors. They provide several functions, including: (1) an advisory function, wherein they offer advice to clients concerning the issuance of new securities; (2) an underwriting function, consisting of the purchase of securities from an issuer and their subsequent sale to investors; (3) a marketing function, involving the sale of the securities to the investing public.

Explain the role of the designated market makers the successors to specialists. Refer to the NYSE for information

Specialists (designated market makers) are members of exchanges who are assigned to particular stocks on an exchange. They are charged by the exchange with maintaining a continuous, orderly market in their assigned stocks. They do this by going against the market, buying (selling) when the public is selling (buying). Specialists act as brokers by executing orders for other brokers for a commission. They act as dealers by buying and selling specific stocks for their own accounts. Specialists should be, and are, closely monitored and regulated. Because they maintain the limit books, they have knowledge of all limit orders on either side of the current market price. They are charged with acting for the public interest by maintaining an orderly market; simultaneously, they buy and sell for their own accounts in hopes of profiting from the spread between purchases and sales. Clearly, specialists must be closely regulated because of these potentially conflicting roles.

what would have a greater impact on DIJA: a 10% change in the price of Visa or a 10% change in the price of Pfizer?

Stock prices obviously change over time. In 2016, Visa was selling at nearly 2.5 times the price of Pfizer. Therefore, a 10% change in Visa would have a much larger impact on the DJIA. However, since each is only one of 30 stocks, the overall change in the index from a 10% change would be rather small.

What is survivorship bias? how does it affect investors in judging mutual fund performance?

Survivorship bias refers to the fact that when investors observe a set of mutual fund returns over time, they are seeing results for those mutual funds that survived over that period of time. Some poorly performing funds may be done away with, typically by merging them with another mutual fund in the same company. Alternatively, some are started by mutual fund companies but are never sold to the public because of poor performance. Thus, investors see only the "survivors." Investors are not able to judge mutual fund performance fully because of the survivorship bias. The actual performance record for a set of mutual funds over time is overstated because only the record of the survivors is seen.

What is the difference between a load fund and a no-load fund?

The "load" refers to the sales charge. A no-load fund has no sales charge, while a load fund has a sales charge, which may be as much as 5-6 percent. A low-load fund has a lower sales charge, such as 2 percent.

what is the EAFE Index?

The EAFE Index, or the Europe, Australasia, and Far East Index, is a value-weighted index of the equity performance of major foreign developed markets. It is, in effect, a non-American developed market index.

approximately how many stocks are listed on the NYSE? does NASDAQ have more listed?

The NYSE has approximately 2,400 common stocks listed. Nasdaq typically has more, although the number has declined in recent years.

why can the nyse now describe itself as a hybrid market, given its long history of using specialists?

The NYSE merged with Archipelago, an ECN. It now describes itself as a hybrid market because it can offer trading using the traditional specialist system, or trading using the fully computerized ECN technology, which offers very quick execution.

why do you think that the NYSE in 2005 agreed to a merger with ArcaEx, a very different type of market place?

The NYSE was seeking a way to offer its customers almost instantaneous execution of orders, which some institutional investors want. They probably also realized that the future of trading is going to more heavily emphasize this type of trading.

What are some of the goals for an investment company?

The board of directors of an investment company must specify the objective that the company will pursue in its investment policy. The company will try to follow a consistent investment policy, given its objective. (a) common stock funds: aggressive growth, growth, growth and income, international, and precious metals (b) balanced funds: hold both bonds and stocks (c) bond and income funds: income funds, bond funds, municipal bond funds and option/income funds (d) specialized funds: index funds, dual-purpose funds, and unit investment trusts.

What is the structure of equity markets in the US? What are auction markets vs. negotiated markets?

The equity markets in the United States consist primarily of the organized exchanges-- the NYSE (part of Intercontinental Exchange (ICE)) and Nasdaq (approved to be an exchange in January 2006). Over-the-counter securities are now traded on the OTC Bulletin Board or the Pink Sheets LLC. • Auction markets, involving the NYSE and any regional exchanges, include a bidding (auction) process in a specific physical location with brokers representing buyers and sellers. • The NYSE is now a hybrid market, following its merger with Archipelago, an ECN. • Nasdaq is a negotiated market, where dealers make the market in securities by standing ready to buy from, and sell to, investors based on bid-ask prices.

how do you calculate NAV?

The net asset value (NAV) for any investment company share is computed daily by calculating the total market value of the securities in the portfolio, subtracting any trade payables, and dividing by the number of investment company fund shares currently outstanding.`

Why do people use morning star ratings? what is a potential problem with them?

The traditional Morningstar ratings provide investors with a convenient, quickly understood rating system for mutual funds based on their performance. One knows immediately that a 5-star fund is a top-rated fund and a 1-star fund is a bottom-rated fund. Looking at a set of, say 20 funds, one can easily pick out the good performers. The weakness of this system is that the ratings are based on past performance, and there is a strong likelihood that performance will not continue as is. Therefore, many top-rated funds will subsequently stumble, while some poorly rated funds will perform better. In November 2011, Morningstar implemented a forward-looking ranking system for mutual funds that supplements the star-ratings system. While the latter measures past performance, the new system attempts to predict which funds will outperform in the future. It incorporates not only past performance but also the expense ratio, the fund's investing strategy, and other information concerning the fund's manager and parent company.

How would a fund owner cash out?

When the investor is ready to sell the shares of Equity-Income Fund, he or she would contact Fidelity by phone, mail, or online and instruct Fidelity to sell the shares. The company is obligated to do so under normal circumstances at the NAV prevailing at the time of sale

Assume the Coke and Visa, which are both on DIJA and S&P, have about the same market value, but ver differet market prices. Would a 5% move in each stock have aobut the same effect on the S&P 500 index?

Yes. This can be shown by constructing a simple example of price X number of shares for each stock.