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5 - Chapter Five The Financial Services Industry Mutual...

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Chapter Five The Financial Services Industry: Mutual Funds Chapter Outline Introduction Size, Structure, and Composition of the Industry Historical Trends Different Types of Mutual Funds Mutual Fund Objectives Investor Returns from Mutual Fund Ownership Mutual Fund Costs Balance Sheet and Recent Trends Money Market Funds Long-Term Funds Regulation Global Issues Summary Appendix 5A – Hedge Funds 40
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Solutions for End-of-Chapter Questions and Problems: Chapter Five 1. What is a mutual fund? In what sense is it a financial intermediary? A mutual fund represents a pool of financial resources obtained from individuals and companies, which is invested in the money and capital markets. This process represents another method for economic savers to channel funds to companies and government units that need extra funds. 2. What are money market mutual funds? In what assets do these funds typically invest? What factors have caused the strong growth in this type of fund since the late 1970s? Money market mutual funds (MMMFs) invest in assets that have maturities of less than one year. These assets primarily are Treasury bills, negotiable certificates of deposit, repurchase agreements, and commercial paper. The growth in MMMFs since the late 1970s initially occurred because of rising interest rates in the money markets, while Reg Q restricted interest rates on accounts in depository institutions. Many investors moved their short-term savings from the depository institutions to the MMMFs as the spread in the earnings rate reached double digits. A result of this activity was to introduce many investors to the capital markets for the first time. 3. What are long-term mutual funds? In what assets do these funds usually invest? What factors caused the strong growth in this type of fund during the 1990s? Long-term mutual funds primarily invest in assets that have maturities of more than one year. The most common assets include long-term fixed-income bonds, common stock, and preferred stocks. Some money market assets are included for liquidity purposes. The growth in these funds in the 1990s reflected the dramatic increase in equity returns, the reduction in transaction costs, and the recognition of diversification benefits achievable through mutual funds. 4. Using the data in Table 5-3, discuss the growth and ownership holding over the last twenty years of long-term funds versus short-term funds. The dollar investment in the money market mutual funds (MMMF) exceeded the investment in the long-term funds (LTF) in 1980. However, by 2001, the LTFs had more than a two to one advantage on the MMMFs, $4,135 billion to $2,241 billion. The LTF grew at an annualized rate of 22.2 percent, and the MMMF grew at an annualized rate of 17.5 percent. In each type of fund, the largest investment source was the household sector, with growth of 21.8 percent annual rate for the LTF and 14.7 percent for the MMMF.
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