Principles of Investment Test: Chapters 6&7.

an alternative strategy to capitalization-based investing:

"style" investing based on value or growth

Index fund offer investors:

(especially those with modest funds) a means to participate in the equity markets without having to select individual stocks.

front-end load fees and exit fees affect:

the investor's realized return and increase the difficulty of comparing the performance reported by the fund and the return actually realized by the investor

go with the "hot hands"

the large amount of publicity in the popular financial press given to the funds that do well during a particular time period encourages individuals to invest in those funds.

large cap stocks

the largest companies, with market value exceeding $10 billion

capitalization

the market value of the company

Prior to 2008: (Safe)

the risk of loss from an investment in a money market mutual fund was considered virtually nonexistent. Money market mutual fund shares were always priced at their $1.00 NAV. The short-term debt instruments held by the fund could decline and cause the NAV to fall below the $1.00 (called "breaking the buck").

If an investor owns shares in a mutual fund and wants to liquidate the position::

the shares are sold back to the mutual fund minus any applicable sales charge. The shares are redeemed at their NAV, and the fund pays the investor from its cash holdings. If the fund lacks sufficient cash, it will sell some of the securities it owns to redeem the shares. The fund cannot suspend this redemption feature except in an emergency, and then it may be done only with the permission of the Securities and Exchange Commission. Most funds do charge an "exit fee" if the investor has held the shares for at least six months.

Investment style is built around

the size of the firms acquired by the fund or the approach (growth or value) used to select stocks for inclusion in the portfolio.

a style portfolio manager offers the investor two things:

the style the investment skill

the yields earned on investments in money market funds closely mirror:

the yields on short-term securities

front-end load fees and exit fees apply only to:

those individuals who are buying and redeeming shares and do not apply to other shareholders who are neither buying nor redeeming shares.

Investment companies were established during the 1860's in what country?

Britain

After the 2008 financial crisis: (Liquid)

Lehman filed for bankruptcy, and defaulted on its commercial paper. the value of several money funds fell below $1.00, which caused investors to rush to withdraw funds. Such withdrawals would have the same effect as the runs on banks during the 1930s. The money funds could not liquidate sufficient assets at their face value and sustain the $1.00 NAV of mutual fund shares. In order to stop the run on money market mutual funds, the U.S. Treasury offered temporary guarantees for most money market funds and the Federal Reserve guaranteed certain commercial paper issuers. These actions by the U.S. Federal Government stopped massive withdrawals from the money funds.

"family of funds"

Many investment management firms offer a wide spectrum of mutual funds, referred to as a "family of funds." Each fund has a separate financial object and hence a different portfolio. gives a variety of funds from which to choose generally permits the individual to shift investments from one fund to another within the family without paying fees. Such a shift is achieved by redeeming the shares in the growth fund and buying shares in the income fund. While the redemption is a taxable event (unless the shares are in a tax-deferred account such as an IRA), the investor may make the switch without paying commissions on the transactions.

investment companies receive special tax treatment:

Their earnings (i.e., dividend and interest income received) and realized capital gains are exempt from taxation. Instead, these earnings are taxed through their stockholders' tax returns. Their dividends, interest income, and realized capital gains (whether they are distributed or not) must be reported by their shareholders, who pay the appropriate income taxes.

Because there is no secondary market in the shares of mutual funds:

There is no price. You cannot specify market orders, limit orders, or stop-loss orders for the purchase and sale of mutual funds. You pay the NAV plus any applicable load fees and receive the NAV minus any applicable exit fees.

investment style refers to:

the fund's investment philosophy or strategy. Possible styles include the size of the firms acquired by the fund or the approach used to select securities.

"socially responsible" shares in a fund:

These funds invest in the securities that produce socially desirable goods and services or pursue socially desirable policies. Of course, what is socially desirable is determined by each individual. Information on socially responsible funds may be obtained from the Forum for Sustainable and Responsible Investment, a nonprofit organization that promotes the practice of social investing. Information about social investing and social economics may be found through Green America.

the portfolios of investment companies may be:

diversified or specialized

style box

a convenient means to summarize the portfolio strategy of a particular fund. The general form covers value/growth and capitalization.

Fidelity Fund

a growth fund emphasizing larger companies that are considered to offer capital appreciation but whose earnings are more stable and reliable

small cap stocks

a much smaller firm, perhaps with a total value of less than $1 billion.

load fund

a mutual fund that charges a commission to purchase or sell its shares

no-load mutual funds

a mutual fund that does not charge a commission for buying and selling its shares

money market mutual fund

a specialized investment company makes only short-term investments acquires money market instruments shares in money funds have become popular investments

a "value" manager

acquires stock that is undervalued or "cheap."

Mutual Fund Returns

advantages do not necessarily include superior returns. Tendency to underperform the market after costs. Returns are consistent with the efficient market hypothesis.

Exchange Traded Fund (ETF)

an investment company whose shares are traded on an exchange. Essentially, ETFs are similar to a closed-end investment company, since their shares are not bought from the fund but are bought and sold like stocks in the secondary markets. ETFs have become extremely popular investment vehicles that offer investors an array of alternatives to traditional financial assets and mutual funds.

load fee

an investor purchases shares directly from the fund at the NAV plus any applicable sales charge load charge, or simple "load" After receiving the cash, the mutual fund issues new shares and purchases assets with the newly acquired funds. charged to investor when the shares are purchased. compensates the sales person (i.e., is analogous to brokerage commissions for buying securities) varies with dollar amount invested load expenses cause investors to pay a premium over the fund's NAV

mutual fund

an open-end investment company investment companies whose shares are not traded in the secondary markets like stocks and bonds.

Growth funds stress:

appreciation in the value of the assets give little emphasis to current income.

Income funds stress:

assets that generate dividend and/or interest income.

certificates of deposits (CDs)

bank instruments, i.e., savings CDs. Not traded

mid cap stocks

between the two extremes (large cap and small cap stocks); between $1 billion and $10 billion. Some classifications further divide small cap into micro or mini cap for even smaller firms.

cap is short for:

capitalization

the more traditional funds may be:

classified by investment type or investment style

two types of investment companies

closed-end open-end

The portfolio of the Value Line Income Fund consists of:

common stocks of companies with potential for growth. These growth stocks may include large, well-known companies and smaller companies that may offer superior growth potential.

management fee

compensates the investment advisor for the general management of the fund's affairs. This fee generally runs from 0.5 to 1.0% of the fund's assets. investment advisor for general management

operating expenses

cover record keeping, transaction costs, directors' fees, and legal and auditing expenses. The sum of these expenses tends to range from 0.3 to 0.7% of the fund's assets; including management and other expenses, the range increases to 0.8 to 1.7% of the fund's assets. bookkeeping, transaction fees, legal, audit, etc.

exit fees

designed to discouraged frequent redemptions by investors seeking short-term gains. If the investor holds the shares for six months, the charge does not apply.

index fund

duplicates a particular measure (index) of the market. The fund's purpose is almost diametrically opposed to the traditional purpose of a mutual fund. Instead of almost identifying specific securities for purchase, the management of these funds seek to duplicate the composition of an index of the market. tracks an aggregate measure of the market led to the creation of exchange traded funds.

fees and expenses

each mutual fund is required to disclose in its prospectus these various costs. These costs associated with researching specific assets, brokerage fees charged when the fund buys and sells securities, and compensation to management are all costs that the investor must bear. These expenses are the cost of owning the shares and are in addition to any sales fees (loading charges) the investor pays when the shares are purchased. The costs of owning the shares are generally expressed as a percentage of the fund's assets.

After the initial success of the index fund, a variation was created:

exchange traded funds, commonly referred to as ETFs

Factors that affect returns:

expenses fees (load fees and exit fees; 12b-1 fees) movements in the market

"style" investing based on value stresses:

fundamental analysis based on analytical tools such as comparisons of financial statements and P/E ratios.

a "growth" fund portfolio manager:

identifies firms offering exceptional growth based on the industry's potential and the firm's position within the industry.

Value Line Income Fund's objective is:

income

Federal Deposit Insurance Corporation

insures bank deposits up to a specified limit. If a bank were to fail, FDIC would reimburse each deposit up to the limit. As most individuals do not have more than the limit on deposit, these investors know that their principal is safe and will not make a massive run on banks to withdraw deposits.

The returns funds have earned, the fees and expenses they charge, and income and capital gains taxation are:

interrelated because higher expenses reduce returns, and taxes reduce the amount of the return the investor gets to keep. Looking at only one of these considerations, such as a fund's historical returns, may be misleading.

money market mutual fund

investment companies that acquire money market instruments. specialize solely in short-term assets and provide investors with an alternative to savings and time deposits offered by banks. compete directly with commercial banks and other depository institutions for the deposits of savers, while regular mutual funds offer an alternative means to own stocks and bonds.

most mutual funds are created by:

investment management companies that administer money for institutional investors such as pension plans, foundations, and endowments. These money management firms include commercial banks, insurance companies, and investment counsel/planning firms.

Schwab U.S. Treasury Money Fund

invests solely in U.S. government securities, or government-backed securites, that are collateralized by obligations of the federal government. the yield it offers investors mirrors the return on these government securities. This relationship must occur because when the short-term debt held by the fund matures, the proceeds can be reinvested only at the going rate of interest paid by short-term government securities. Hence changes in short-term interest rates paid by these securities are quickly transferred to the individual money market mutual fund.

The loading fee

ranges from zero for no-load mutual funds to between 3 and 6% for load funds

negotiable certificates of deposits (CDs or "jumbo" CDs)

issued by commercial banks "negotiable", which means they may be bought and sold. The ability to buy and sell jumbo CDs differentiates from the certificate of deposit that most savers acquire. Savings CDs cannot be bought early and sold; you redeem them at the issuing bank and probably pay a penalty for early redemption. Jumbo CDs are also differentiated from savings CDs because they are issued in units of $100,000, which precludes most individual investors from acquiring negotiable CDs. a certificate of deposit in which the rate and the term are individually negotiated by the bank and the lender and which may be bought and sold.

U.S. Treasury bill (T-bill)

issued by the federal government Prior to the political confrontations over the federal budget in 1995 and 2011, there was no question that the federal government would retire the principal and pay the interest on its obligations. The short term of the bills also implies that if interest rates were to rise, the increase would have minimum impact on the bills, and quick maturity means that investors could reinvest the proceeds in the higher-yielding securities. very risk-free short-term debt of the federal government short-term government debt, 3-12 month maturity.

closed-end investment companies

issues a fixed number of shares bought and sold in secondary securities markets closed to new investors

After a mutual fund is created:

it has its own portfolio managers who select the assets included in the fund's portfolio. The originating investment management company then becomes an advisor to the fund.

When you place an order during the day:

it is executed at the net asset value as of the end of the day.

3 types of firm size:

large cap mid cap small cap

If a portfolio manager's style stresses small cap growth, that fund's performance should not be compared to the performance of:

large cap funds. Only through a consistent comparison of funds with similar strategies or styles can the portfolio manager's investment skill be isolated.

fees and expenses affect the return earned by the investor:

management fees and 12b-1 fees are paid from the fund's income before determining the fund's earnings available to shareholders. These expenses are across all shares and are already accounted for in the return reported by the fund. Presumably, lower expenses contribute to a higher return, and differences in expenses among the funds may be a reason for selecting a particular fund.

Specialized mutual funds

may be limited to the securities of a particular sector of the economy, or a particular industry, or specialize in a particular type of security (such as bonds). You may acquire shares in a fund that pursues assets in companies that are considered "socially responsible."

Types of money market instruments that money market mutual funds can invest in:

negotiable certificates of deposits Eurodollar CDs treasury bills commercial paper repurchase agreements banker's acceptances tax anticipation notes

12b-1 fees

non-essential costs. special charges for marketing and distribution services and may include commissions to brokers who sell the shares. "marketing" fees

open-end investors

number of shares varies as investors buy more shares from the trust or sell them back to the trust. buy and sell shares to and from the company. commonly called a mutual fund started in 1924 when Massachusetts Investor Trust offered new shares and redeemed (i.e., bought) existing shares on demand by stockholders.

balanced funds

own a mixture of securities that sample the attributes of many types of assets

The Fidelity Balanced Fund

owns a variety of stocks, some of which offer potential growth while others are primarily income producers.

taxation

pass through vehicles investors, not the investment company, pays taxes on income and capital gains. cannot be traded like stocks no market orders, limit orders, etc.

Index funds are essentially:

passive investments, since the fund duplicates the index. Once the portfolio is constructed, changes are infrequent and occur in response to changes in the composition of the index. Such minimal changes reduce the cost of managing the fund, so they are a cost-effective means to buy the market.

investment trusts initially sought to

pool the funds of many savers to create a diversified portfolio of assets. Such diversification spread the risk of investing and reduced the risk of loss to the individual investor. While a particular mutual fund had a specified goal, such as growth or income, the portfolio was still sufficiently diversified so that the element of firm-specific, unsystematic was reduced.

One of the advantages associated with investing in mutual funds is:

professional management, but this management cannot guarantee to outperform the market. In the aggregate, funds do not tend to outperform the market and this inferior return is often accompanied by increased, not decreased, risk.

open-end

referred to as a mutual fund generally more popular

factors to consider when selecting mutual funds:

returns funds have earned the fees and expenses they charge. income and capital gains taxation.

repurchase agreement (repos)

sale of a short-term security in which the seller agrees to buy back the security at a specified price at a specified date. Repos are usually executed using federal government securities, and the repurchase price is higher than the initial sale price. The difference between the sale price and the repurchase price is the source of the return to the holder of the security. By entering into the repurchase agreement, the investor (the buyer) knows exactly how much will be made on the investment and when the funds will be returned.

a balanced fund's portfolio includes:

short-term debt securities (e.g., Treasury bills), bonds, and preferred stock. Such a portfolio seeks a balance of income from dividends and interest plus some capital appreciation.

Tax anticipation notes

short-term government security secured by expected tax revenues. issued by states or municipalities to finance current operations before tax revenues are received. As taxes are collected, the proceeds are used to retire the debt. Similar notes are issued in anticipation of revenues from future bond issues and other sources, such as revenue sharing from the federal government. These anticipation notes do not offer the safety of Treasury bills, but the interest is exempt from federal income taxation. Commercial banks and securities dealers maintain secondary markets in them, so the notes may be liquidated should the noteholder need cash. issued by states or municipalities secured by expected tax revenues

banker's acceptances

short-term promissory note guaranteed by a bank. These acceptances arise through international trade. Banker's acceptances are considered to be good short-term investments because they are supported by two parties: the firm on which the draft is drawn and the bank that accepts the draft.

commercial paper

short-term promissory notes (i.e., debt) issued by the most creditworthy corporations issued by a corporation as an alternative to borrowing funds from commercial banks. Only firms with excellent credit ratings are able to sell commercial paper; hence, the risk of default is small, and the repayment of principal is virtually assured. Once again, the term is short, so there is little risk from an investment in commercial paper.

money market instruments

short-term securities issued by banks, non-bank corporations, and governments. short-term securities, such as Treasury bills, negotiable certificates of deposits, or commercial paper.

Considerable differences with the class of growth funds:

some funds stress riskier securities in order to achieve faster appreciation and larger returns. Other funds, however, are more conservative.

Even if funds in the aggregate do not outperform the market:

some individual funds may have earned higher returns and continue to perform the market well. That is, the portfolio managers of some funds consistently outperform the market. This argues for purchasing shares in funds that have done well on the premise that the best-performing funds will continue to do well.

virtually all of the Value Line Income Fund's assets are:

stocks such as utilities that distribute a large proportion of their earnings and periodically increase the dividend as their earnings grow.

a total expense ratio of 1.6% indicates:

that the fund's expenses are $1.60 for every $100 of assets. It should be obvious that the fund must earn at least $1.60 for each $100 in assets just to cover these costs, so if a fund earns 11.2% on its assets, the investor nets 9.6%.

When a fund has more than one style it suggests:

that the portfolio manager acquires shares in small companies that appear to be undervalued. Ex. A "small-cap growth" fund would stress small companies that offer exceptional growth potential but are not necessarily operating at a profit and are not perceived as unvalued.

Rushmore Over-the-Counter Index plus (less broadly based) is based on:

the Nasdaq 100 stock index, and is limited to the 100 largest over-the-counter stocks.

The Vanguard Index Trust-500 Portfolio is based on:

the Standard & Poor's 500 stock index.

The Vanguard Index Trust-Extended Market Portfolio is based on:

the Wilshire 5000 stock index, which is even more broadly based than the S&P 500 stock index.

Advantages offered by mutual funds:

the advantage of professional management of their money the benefit of ownership in a diversified portfolio. the potential savings in commissions, as the investment company buys and sells in large blocks. Custodial services (e.g., the collecting and disbursing of funds).

net asset value

the asset value of a share in an investment company; total assets minus total liabilities (e.g., accrued fees) divided by the number of shares outstanding. the net worth of the fund divided by the number of shares outstanding. extremely important for the valuation of an investment company, for it gives the value of the shares should the company be liquidated. Changes in the NAV alter the value of the investment company's shares. Thus, if the value of the fund's assets appreciates, the NAV will increase, which may also cause the price of the investment company's stock to increase.

investment type refers to:

the class or type of securities the fund acquires, such as income-producing bonds.

Eurodollar certificates of deposits (Eurodollar CDs)

time deposit in a foreign bank and denominated in dollars similar to US savings CDS, but European. Large American banks with foreign operations also issue Eurodollar CDs. These CDs are similar to negotiable CDs except they are issued either by the branches of domestic banks located abroad or by foreign banks. Eurodollar CDs are denominated in dollars (instead of a foreign currency) and are actively traded, especially in London, which is the center of the Eurodollar CD market. Because they are issued in a foreign country, these CDs are considered riskier than domestic CDs, so Eurodollar CDs offer higher yields to induce investors to purchase them.

investment companies were initially referred to as

trusts because the securities were held in trust for the firm's stockholders. used the funds that were obtained through the sale of the stock to acquire the shares of other firms specified number of shares.

contrarian investors

use value approach try to identify strong stocks that are currently out of favor investors who go against the consensus investment strategy

Funds that have a specialization in a sector, industry, or security:

usually diversified within their area of concentration. The portfolio is diversified even though the fund is specialized.

Open-end investment companies-mutual funds

variable capital structure shares are bought and sold (redeemed) from the mutual fund shares cannot sell for a discount from the NAV

front-end load fees are paid:

when the shares are purchased

exit fees are paid:

when the shares are redeemed.

If the NAV rises during the day:

you will pay more than you anticipated. The reverse applies to redemptions; you may receive less. `