Chapter 04_Hand-out 3

Chapter 04_Hand-out 3 - CHAPTER 4 MUTUAL FUNDS AND OTHER...

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CHAPTER 4 MUTUAL FUNDS AND OTHER INVESTMENT COMPANIES 4.1 INVESTMENT COMPANIES Investment companies are financial intermediaries that collect funds from individual investors and invest those funds in a potentially wide range of securities or other assets. Pooling of assets is the key idea behind investment companies. Each investor has a claim to the portfolio established by the investment company in proportion to the amount invested. These companies thus provide a mechanism for small investors to "team up" to obtain the benefits of large-scale investing. Investment companies perform several important functions for their investors: - Record keeping and administration; - Diversification and divisibility; - Professional management; - Lower transaction costs. While all investment companies pool assets of individual investors, they also need to divide claims to those assets among those investors. Investors buy shares in investment companies, and ownership is proportional to the number of shares purchased. The value of each share is called the net asset value, or NAV . Net asset value equals assets minus liabilities expressed on a per-share basis. NAV = Market value of assets - Liabilities/Shares outstanding 4.2 TYPES OF INVESTMENT COMPANIES In the United Stated, investment companies are classified by the Investment Company Act of 1940 as either unit investment trusts or managed investment companies. 1. Unit Investment Trusts Unit investment trusts are pools of money invested in a portfolio that is fixed for the life of the fund. To form a unit investment trust (UIT), a sponsor, typically a brokerage firm, buys a portfolio of securities which are deposited into a trust. It then sells to the public shares, or "units" in the trust, called redeemable trust certificates. All income and payments of principal from the portfolio are paid out by the fund's trustees (a bank or trust company) to the shareholders. Most unit 1
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trusts hold fixed-income securities and expire at their maturity, which may be short-term securities like money market instruments, or long-term assets like fixed-income securities. There is little active management of a unit investment trust because once established, the portfolio composition is fixed: hence these trusts are referred to as unmanaged . Trusts tend to invest in relatively uniform types of assets; for example, one trust may invest in municipal bonds, another in corporate bonds. The uniformity of the portfolio is consistent with the lack of active management. The trusts provide investors a vehicle to purchase a pool of one particular type of asset, which can be included in the overall portfolio as desired. The lack of active management of the portfolio implies that management fees can be lower than those of managed fund. Sponsors of unit investment trust earn their profit by selling shares in the trust at a
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This note was uploaded on 09/25/2011 for the course FINA 4320 taught by Professor John during the Spring '11 term at Houston Baptist.

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Chapter 04_Hand-out 3 - CHAPTER 4 MUTUAL FUNDS AND OTHER...

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