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Learning objectives: Differentiate among open-end mutual funds, closed-end mutual funds, and exchange-traded funds (ETFs). Calculate the net asset value (NAV) of an open-end mutual fund. Explain the key differences between hedge funds and mutual funds.

Questions:

705.1 America's Best Fund (Class A) is an open-ended mutual fund with 1.20 million shares outstanding. Currently, it is 10 am U.S. eastern standard time (EST) in the morning and the fund owns the following:
  • $9.30 million in large cap equities,
  • $1.0 million in short-term U.S. Treasury bills; aka, the risk-free asset, and
  • $500,000 in cash
Which of the following statements is TRUE?

a. The fund's net asset value (NAV) is about $7.75 per share
b. If the fund reinvests dividends earned on the equities, the fund's investors are not taxed on these reinvested dividends
c. An immediate order to buy shares, at 10 am, can specify the total dollar amount but will know neither the exact NAV nor exact number of shares purchased
d. Unless and until the fund issues additional shares in a secondary offering or initiates a share buyback, the number of shares outstanding will remain fixed at 1.20 million


705.2. The Investment Committee at your endowment just analyzed the historical performance of its asset allocation to hedge funds, which was 20.0% of the fund. It has determined that net of fees these hedge funds did not outperform the S&P 500 on a risk-adjusted basis. Consequently, the Committee wants to re-allocate this portion to a fund that tracks the S&P 500 index; and the Committee is comfortable mirroring the index with minimum tracking error. An outside consultant proposes an exchange-traded fund (ETF) such as the "Spider" (ticker SPY), but some members want to compare the ETF to an open-ended or closed-ended mutual fund that tracks the S&P 500.

In addition to highlighting the fact that the expense ratios tend to be lower for ETFs than mutual funds, the consultant offers the following arguments in favor of an ETF:

I. In contrast to an open-ended mutual fund, advantage of the SPDR ETF can be traded at any time, can be shorted, and does not have to be partially liquidated to accommodate redemptions
II. In contrast to a closed-ended mutual fund whose price tends to trade at a discount to its fair market value, there is never any appreciable difference between the traded price of the SPDR EFT and its fair market value.

Which of the consultant's argument(s) is (are) TRUE?

a. Neither is true
b. Only I. is true, but II. is false
c. Only II. is true, but I. is false
d. Both are true.


705.3 Quadholding Mutual is a mutual fund in the United States who reports the following sequence of per annum returns over the last five years: +7.0%, +15.0%, +20.0%, +5.0%, +18.0%. Quadholding Mutual charges a back-end load of 2.0%. Each of the following statements about this mutual fund is true EXCEPT which is false?

a. Quadholding's five-year geometric mean must be less than 13.0%
b. Unlike a hedge fund, Quadholding must disclose its investment policies, must limit it its use of leverage, must calculate NAV daily, and must make its shares redeemable at any time
c. When purchasing shares in Quadholding, a 2.0% fee will be charged to the investor; and if the shares are held for five years then subsequently sold, then the total expense ratio amortizes to about 40 basis points per year
d. Quadholding is heavily regulated primarily by the Securities and Exchange Commission (SEC) who does not permit the illegal practice of "late trading;" although investors can legally engage in "market timing" or "front running" the fund but only if such trades are based on publicly available information

Answers here:
 
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