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# P1.T3.21.6. Mutual funds

#### Nicole Seaman

##### Director of FRM Operations
Staff member
Subscriber
Learning objectives: Differentiate among open-end mutual funds, closed-end mutual funds, and exchange-traded funds (ETFs). Identify and describe potential undesirable trading behaviors at mutual funds. Calculate the net asset value (NAV) of an open-end mutual fund. Explain the key differences between hedge funds and mutual funds.

Questions:

21.6.1. The Fast Torpedo fund is a closed-end mutual fund that invests in companies. The fund's average investor has a six-year holding period. The fund pays no dividends. The expected return from the fund's assets (not the fund itself) is 9.0% per annum with annual compound frequency. The management fee is 70 basis points (0.70%) per annum. The net asset value (NAV) of the fund happens to be $100.00 per share. Which of the following is most likely to be the fund's price per share? a.$96.40
b. $100.00 c.$115.00
d. \$231.31

21.6.2. Molly recently inherited a small windfall and is trying to decide where to invest the money. She does not want to pick stocks. She would prefer to invest in either an index fund, a mutual fund (i.e., either open- or closed-end), or an exchange-traded fund (ETF). She is evaluating the following four funds:
• Fund I: The share price trades at its net asset value (NAV) with a fluctuating number of shares, but it cannot be shorted and the trades are executed at the end of the business day
• Fund II: The share price generally trades at a discount (but sometimes at a premium) to its NAV with a fixed number of shares; it can be shorted and can be traded any time
• Fund III: The share price is equal to (or approximately equal to) the NAV because its assets are disclosed twice each day; it can be shorted and can be traded at any time
• Fund IV: This fund consistently has a very small tracking error of less than 10 basis points relative to the NASDAQ-100 Index and its fees are very low because there is no active management
Which of the following correctly matches the fund's characteristics to its type?

a. I = Index fund, II = open-end mutual fund, III = closed-end mutual fund, IV = exchange-traded fund (ETF)
b. I = open-end mutual fund, II = closed-end mutual fund, III = exchange-traded fund (ETF), IV = Index fund
c. I = exchange-traded fund (ETF), II = Index fund, III = open-end mutual fund, IV = closed-end mutual fund
d. I = closed-end mutual fund, II = exchange-traded fund (ETF), III = Index fund, IV = open-end mutual fund

21.6.3. Consider the following four mutual funds and their respective behaviors:
• Fund A is an open-end fund that engages in "late trading" by accepting orders after 4 pm
• Fund B engages in "front running" by allowing its traders to make profitable trades in their own accounts ahead of the fund's large block trades
• Fund C engages in "directed brokerage" because it has an informal, reciprocal arrangement that guarantees the fund will use the brokerage for trades but only if the brokerage recommends its clients to the mutual fund
• Fund D engages in "timing the market" because, among its watchlist of 100 stocks, it buys (sells) whenever the price moves two standard deviations below (above) its 200-day moving average
Each of these behaviors is undesirable (or illegal) EXCEPT which is acceptable; i.e., which of the following statements is TRUE?

a. Fund A's behavior is permitted by the SEC
b. Fund B's behavior is legal
c. Fund C's behavior is encouraged by regulators
d. Fund D's behavior is permitted by regulators