1 Chapter 23 Mutual Fund Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Background on mutual funds Stock mutual fund categories Bond fund categories Growth and size of mutual funds Performance of mutual funds Mutual fund scandals 3 Chapter Outline (cont’d) Money market funds Hedge funds Real estate investment trusts Interaction with other financial institutions Use of financial markets Globalization through mutual funds 4 Background on Mutual Funds Mutual funds: Serve as a financial intermediary by pooling investments by individual investors and using the funds to accommodate financing needs by governments and corporations in the primary market Frequently invest in securities in the secondary market Provide an important service for individuals who wish to invest funds and diversify Offer liquidity if they are willing to repurchase an investor’s shares upon request Offer various different services, such as transfers between funds and check-writing privileges 5 Background on Mutual Funds (cont’d) A mutual fund hires portfolio managers to invest in a portfolio of securities that satisfies the desires of investors The portfolio composition is adjusted in response to changing economic conditions The board of directors: Monitors management Establishes procedures Ensures that the fund is properly serving its shareholders Under new SEC rules, a majority of board members must be outsiders 6 Types of funds Open-end funds: Are open to investment from investors at any time Allow investors to purchase or redeem shares at any time Have a constantly changing number of shares Maintain some cash in case redemptions exceed investments Consist of many different categories to satisfy investors’ investment needs Background on Mutual Funds (cont’d) 7 Types of funds (cont’d) Closed-end funds: Do not repurchase shares they sell Require investors to sell the shares on a stock exchange Have a constant number of outstanding shares Have an asset size that is about 1/40 th of the asset size of open-end funds Focus primarily on bonds and other debt securities Background on Mutual Funds (cont’d) 8 Types of funds (cont’d) Exchange-traded funds: Are designed to mimic particular stock indexes and are traded on a stock exchange Differ from open-end funds in that their shares are traded on an exchange, and their share price changes throughout the day Consist of a fixed number of shares Are not actively managed Have become very popular in recent years Typically do not have capital gains and losses that must be distributed to shareholders Background on Mutual Funds (cont’d) 9 Types of funds (cont’d) Hedge funds: Sell shares to wealthy individuals and financial institutions and use the proceeds to invest in securities Differ from open-end funds because: They require a much larger initial investment They may not always accept additional investments or accommodate redemption They are unregulated and provide very limited information to prospective investors They invest in a wide variety of investments to achieve high returns Background on Mutual Funds (cont’d) 10 Comparison to depository institutions Mutual funds repackage the proceeds from individuals to make various types of investments Investing in mutual funds represents partial ownership Investors share the gains or losses generated by the fund Regulation and taxation Mutual funds must register with the SEC and provide a prospectus Mutual funds are regulated by state laws If a mutual fund distributes 90 percent or more of its taxable income to shareholders, it is exempt from taxes on dividends, interest, and capital gains Background on Mutual Funds (cont’d) [...]... foreign securities Returns on international funds are affected by the foreign companies’ stock prices and the movements of the currencies that denominate the stocks Global funds include some U.S stocks 23 Stock Mutual Fund Categories (cont’d) Specialty funds focus on a group of companies sharing a particular characteristic e.g., Index funds are designed to match the performance of an existing stock . 1 Chapter 23 Mutual Fund Operations Financial Markets and Institutions, 7e, Jeff Madura. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Background on mutual funds Stock mutual fund categories