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Unformatted text preview: ANSWERS TO END-OF-CHAPTER QUESTIONS 3-1. Indirect investing involves the purchase and sale of investment company shares. Since investment companies hold portfolios of securities, an investor owning investment company shares indirectly owns a pro-rata share of a portfolio of securities. 3-2. An investment company is a financial corporation organized for the purpose of investing in securities, based on specific objectives. • Open-end investment companies (mutual funds) continually sell and redeem their shares, based on investor demands. Shareowners deal directly with the company. • Closed-end investment companies have a fixed capitalization, and their shares trade on exchanges or over-the-counter. 3-3. “ Open-end” means that the number of shares of the mutual fund outstanding is not fixed. Rather, the number of shares varies as investors buy shares from the mutual fund company and redeem shares back to the mutual fund company. 3-4. An investor may prefer an ETF to a mutual fund because its shares can be bought and sold anytime during the trading day. Shares can also be shorted, and bought on margin. The annual expense ratio is typically lower than that for a mutual fund. Finally, the ETF may be more tax efficient. 3-5. A closed-end fund selling at a discount is technically worth more dead than alive in the sense that if investors could take over the fund, they could liquidate the portfolio and enjoy a gain. Think of a closed-end selling at a 20 percent discount. If assets could be bought for $0.80 on the dollar and liquidated at face value, in principle a nice gain could be realized. Of course, attempts to take over a fund would likely drive the price up and reduce some, or all, of the potential gain. 3-6. An ETF is quite similar to a closed-end fund in that both trade on exchanges, can be sold short and bought on margin. 3-7. A regulated investment company can elect to pay no federal taxes by “flowing through” distributions of dividends, interest, and realized capital gains to shareholders who pay their own marginal tax rates on these distributions. 3-8. The board of directors of an investment company must specify the objective that the company will pursue in its investment policy. The company will try to follow a consistent investment policy, given its objective. (a) common stock funds : aggressive growth, growth, growth and income, international, and precious metals 1 (b) balanced funds : hold both bonds and stocks (c) bond and income funds : income funds, bond funds, municipal bond funds and option/income funds (d) specialized funds : index funds, dual-purpose funds, and unit investment trusts....
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This note was uploaded on 02/13/2012 for the course FINA 3480 taught by Professor Moore during the Spring '11 term at Toledo.
- Spring '11