Tutorial 7

The Mutual Fund Industry

1. Why do mutual funds have different classes of shares?
Different classes of shares offered by mutual funds is determined by the needs of the investors and
their risk preferences. It permits the distributor and its client to select the type of load they prefer.

2. What is an index fund?

An index fund are mutual funds, which invests in stocks included in S&P 500, and aim to achieve its
performance to the benchmark S&P500 returns. Index funds are not actively managed. They simply
hold the stocks in the index. They usually have significantly lower fees than actively managed funds

3. What is the difference between open end and close end mutual fund?
An open end mutual fund is continuously issuing new shares as new funds are received. A closed end
fund only issues shares once.

4. What are the costs incurred by a mutual fund?

Costs typically incurred by an investment company (Mutual fund) include advisory fees,
selling/marketing expenses, custodial/accounting fees, and transactions costs. There are two types of
costs borne by investors in mutual funds. The first is shareholder fee, usually called the sales charge.
This type of charge is related to the way the fund is sold or distributed. The second cost is the annual
fund operating expense usually called the expense ratio, which covers the fund’s expenses. The largest
of which is for investing managements.

5. What is a load fund? Upfront fee

A load fund charges a fee for accepting investments. The fees may be at the beginning of the
investment or may be charged when the funds are withdrawn. At the beginning is a front end load
with a fee of 1- 2% but some exceed to 6%. Fees charged when funds are withdrawn is known as
deferred fund.

6. An investment company has $1.05 million of assets, $50,000 of liabilities, and 10,000 shares
outstanding.
a. What is its NAV?
b. Suppose the fund pays off its liabilities while at the same time the value of its assets double. How
many shares will a deposit of $5,000 receive?

Solution:
a. Net asset value = (Total assets minus liabilities) / numbers of shares
will charge upfront fee/
= 1,050,000 – 50,000 = $100 exit fee, normally
10,000 upfront.
will charge expenses
b. Net asset value = 2,100,000 – 0 = $210
10,000
No of shares = 5000 = 23.81 shares.
210
8. A mutual fund charges a 5% upfront load plus reports an expense ratio of 1.34%. If an investor plans
on holding a fund for 30 years, what is the average annual fee, as a percent, paid by the investor?
Solution:
Upfront load = 5%/30 = 0.1667%
The expense ratio is an annual charge, so it remains 1.34%.
The total fees paid = 1.34% + 0.1667%
= 1.5067%.

9. A mutual fund offers “A” shares which have a 5% upfront load and an expense ratio of 0.76%. The
fund also offers “B” shares which have a 3% backend load and an expense ratio of 0.87%. Which
shares make more sense for an investor looking over an 18 year horizon? Find the year horizon that
the investor is indifferent between mutual fund A and mutual fund B.
Solution:
For the “A” shares, the average annual fee = 5%/18 + 0.76% = 1.0378%
For the “B” shares, the average annual fee = 3%/18 + 0.87% = 1.0367%
So, the investor is better off with the “B” shares.
Part B:
5/x + .76 = 3/x + .87 => x = 18.18 years

10. On January 1st, a mutual fund has the following assets and prices at 4:00 p.m.:
Stock Shares owned Price
1 1,000 $ 1.97
2 5,000 $48.26
3 1,000 $26.44
4 10,000 $67.49
5 3,000 $ 2.59

Calculate the net asset value (NAV) for the fund. (Assume that 8,000 shares are outstanding for the fund).
Solution:
$1,970  $241,300  $26,440  $674,900  $7,770
NAV   $119.05/share
8,000

11. On January 2nd, the prices at 4:00 PM are (Assume that 8420 shares are outstanding)

Stock Shares owned Price

1 1,000 $ 2.03
2 5,000 $51.37
3 2,800 $29.08
4 10,000 $67.19
5 3,000 $ 4.42
cash n.a. $ 2408

Calculate the net asset value (NAV) for the fund.

Solution:
$2,030  $256,850  $81,424  $671,900  $13,260  2,408
NAV   $122.08/share
8,420

12. You invested $10,000 10 years ago into Ali Fund which has reported performance (average annual
total return) of 11.12% over this 10-year period. What would your ending wealth position be?
Solution:
on a financial calculator: 10000 PV, 11.12 interest rate, 10 N, 0 pmt, solve for FV = $28,702.67.
Subtract your initial investment of $10,000, which results in $18,702.67 cumulative total dollar
return.