Chapter 17 - Answers to Chapter 17 Questions 1. A mutual...

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Answers to Chapter 17 Questions 1. A mutual fund represents a pool of financial resources obtained from individuals and invested in the money and capital markets. It represents another way for those with extra funds to channel those funds to those in need of extra funds . 2. Investing in mutual funds allows an investor to achieve a greater level of diversification than could likely be achieved by investing in individual stock on one's own account. A single share of a mutual fund could represent ownership in over a thousand different companies. Whereas the investment in the mutual fund might cost one hundred dollars, buying over a thousand individual shares of stock could cost over one hundred thousand dollars. Further, since mutual funds can buy and sell securities in large blocks, its trading cost are much lower than those of the individual investor buying a few shares at a time. 3. 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 during the late 1970s and early 1980s occurred because of rising interest rates in the money markets while rates in depository institutions were restricted by Regulation Q. Many investors moved their short-term savings from the depository institutions to the MMMFs as the spread in the earnings rate reached double digits. 4. 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 and early 2000s reflected the dramatic increase in equity returns. The reduction in transaction costs, and the recognition of diversification benefits achievable through mutual funds. 5. In 2004, 74.3 percent of all mutual fund assets were in long term funds; the remaining funds, or 25.7 percent, were in money market mutual funds. From Table 17-3, the percentage invested in long term versus short term funds can, and has, varied considerably over time. For example, the share of money market funds was 55.2 percent in 1980, 44.8 percent in 1990, 25.8 percent in 1999, 29.0 percent in 2000, and 35.1 percent in 2001. The decline in the growth rate of short term funds and increase in the growth rate of long term funds reflects the increase in equity returns during the period 1980-1999 and the generally low level of short term interest rates over the period. In the early 2000s, as interest rates rose and equity returns fell, growth in money market funds outpaced the growth in long-term funds. Further, despite low interest rates in 2001, the continued drop in equity values resulted in money market fund growth that well outpaced that of long-term funds. In 2003 and 2004, as the U.S. economy recovered and stock values increased, the share of long term funds grew, while money market funds decreased. Money market mutual funds provide an alternative investment opportunity to interest-bearing
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This note was uploaded on 03/22/2012 for the course FINA 210 taught by Professor Dakroub during the Spring '12 term at American University in Cairo.

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Chapter 17 - Answers to Chapter 17 Questions 1. A mutual...

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