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Tutorial 1 Solution Investment Management

The document discusses mutual funds and various related concepts. It addresses why investors may pay front-end loads, the relationship between investment length and loads, how cash balances can impact returns, and examples calculating net asset value and fund returns. Key points covered include compensation for financial advisors, long-term investing benefits, impacts of cash on up and down markets, and formulas for NAV and return calculations.

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Shamiethraa C.Magenthiran
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53 views10 pages

Tutorial 1 Solution Investment Management

The document discusses mutual funds and various related concepts. It addresses why investors may pay front-end loads, the relationship between investment length and loads, how cash balances can impact returns, and examples calculating net asset value and fund returns. Key points covered include compensation for financial advisors, long-term investing benefits, impacts of cash on up and down markets, and formulas for NAV and return calculations.

Uploaded by

Shamiethraa C.Magenthiran
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Lecture 1 –
–Tutorial Solution
________________________________
Concept questions
1. Given that no-load funds are widely available, why would a
rational investor pay a front-end load? More generally, why
don’t fund investors always seek out funds with the lowest
loads, management fees, and other fees?

» While no-load mutual funds are available, investors may


choose to pay a front-end load for several reasons:

» Access to high-quality funds: Some mutual funds with a


front-end load may have a track record of outperforming
their benchmarks or similar funds. Investors may be willing
to pay a front-end load to gain access to these funds, which 2

they believe will provide higher returns over the long-term.


» Financial advisor compensation: Investors who work with a
financial advisor may pay a front-end load as compensation
to the advisor for their services. The advisor may also offer
additional services such as financial planning, tax advice, and
ongoing portfolio management.

» Long-term investing: Investors who plan to hold a mutual


fund for a long period of time may be willing to pay a front-
end load because it can result in lower expenses over time.
Front-end loads are a one-time fee that is deducted from the
initial investment, so the ongoing expenses of the mutual
fund may be lower than a no-load fund with higher expenses.
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Concept questions
2. You are interested in investing in a mutual fund that
charges a front-end load of 5 percent. If the length of your
investment is one year, would you invest in this fund?
Suppose the length of your investment is 20 years? How
are the length of your investment and front-end loads
related?

» Answer: For an investment horizon of just one year, a front-


end load of 5% can significantly reduce the investor's
returns. For 1-year investment period, the cost of investment
is 5% per annum. This means that the investment returns
need to be more than 5% at least. If not, there will be a loss.
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In this scenario, it may not be advisable to invest in the fund
with this high front-end load.
» However, if the investor plans to hold the mutual fund for a longer
period, such as 20 years, the impact of the front load on his overall
returns may be less significant. Over a longer investment horizon,
the effect of the front-end load is spread out over many years and
the investor may benefit from lower ongoing expenses over time.

» Hence, for the 20-year investment period, the 5% front-end will be


only 0.25% per annum, which is very low. In this scenario, there is
higher chances that the investment return in years ahead will be
higher than 0.25%.

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Concept questions
3. An open-end mutual fund typically keeps a percentage, often
around 5 percent, of its assets in cash or liquid money market
assets. How does this affect the fund’s return in a year in which
the market increases in value? How about during a bad year?
Closed-end funds do not typically hold cash. What is it about
the structure of open-end and closed-end funds that would
influence this difference?
» Answer: In an up market, the cash balance will reduce the
overall return since the fund is partly invested in assets with a
lower return. In a down market, a cash balance should help
reduce the negative returns from stocks or other instruments.
An open-end fund typically keeps a cash balance to meet
shareholder redemptions. A closed-end fund does not have 6

shareholder redemptions so very little cash, if any, is kept in the


portfolio.
Question 1. If there are 50,000 shares of the market
fund, what is the NAV for an open-end mutual fund
with the following stocks?
Stock Shares Stock Price ($)
» A 6,000 98
» B 33,000 19
» C 4,600 89
» D 82,500 12

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Net Asset Value = (Value of Funds – Expenses – Liabilities) / Shares Issued

Total Value of Funds:


Total value of portfolio =(6,000 x $98)+(33,000 x $19)+(4,600 x $89)+(82,500 x $12)
Total value of portfolio = $588,000 + $627,000 + $409,400 + $990,000
Total value of portfolio = $2,614,400

Net Asset Value:


= $2,614,400 / $50,000
= $ 52.29

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Question 2. You invested $10,000 in a mutual fund at the beginning
of the year when the NAV was $32.24. At the end of the year the
fund paid $0.24 in short-term distributions and $0.41 in long-term
distributions. If the NAV of the fund at the end of the year was
$35.23, what was your return for the year?

Mutual Fund Return:


Rate of Return = NAV1 – NAV0 + Short-term distributions + Long-term distribution
NAV0
Putting the values:
Rate of Return = ($35.23 - $32.24 + $0.24 + $0.41) / $32.24
Rate of Return = $3.84 / $32.24
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Rate of Return = 0.1129 or 11.29%
Therefore, the return for the year is 11.29%.
Thank you

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