Chapter 19 :

Investment Companies

Required Pages
( Pg568-578, 581-584,586-587,591-594)
Investment company

• Long-term investment unless investing in MM.

• Invest in stocks & Bonds.

• Public or private.
 Investment company importance

• You would like to invest $800 in NYSE.

• Are you able to buy all the following stocks* ?!
– Apple $117
– Google $750
– Microsoft $53
– COACH $31
Of course you can’t !
What if buy a share of Google!
What happen to your portfolio ?!! It will be extremely
volatile!

*Prices according to 28 Nov. 2015

 Investment company importance

Somebody inform you that AE investing in NYSE

by selling their shares for $800 per share.

Investors AE Investment

What is the advantage of investing with AE?Apple ,Google

1.Diversification (Many stocks > lower risk)Microsoft ,COACH
& More companies!
2.Managed by professional managers
Investment company
1. Open-end mutual fund.
2. Closed-end mutual fund.
3. Exchanged-traded fund.
4. Unit investment trusts.
Figure :Investment Company Assets under Management, 2010 ($ Billion)

Clearly, mutual fund (open-end) has the largest portion of investment companies.
 1.Open-End Mutual Fund
Definition : A type of mutual fund that does not have
restrictions on the amount of shares the fund will issue.
Mainly invest for long-term, but there are some type of
open-end fund invest in short term securities.
– If demand is high enough, the fund will continue to
issue shares no matter how many investors there are.

– Open-end funds also buy back shares when investors

wish to sell.

– Therefore, the number of outstanding shares are floating (not fix)

1.Open-End Mutual Fund
• Investing in Stock and Bonds.
• Also known as “Mutual Fund”.
• Represent largest share of investment
company
– Almost 91% of investment companies are open-end
fund.
 1.Open-End Mutual Fund
Example :
Mesa Fund hold only two stocks :
– Seven shares of Hardy Pizza, currently selling for $100.
– 31 shares of Dolezilek. Power, currently selling for $10.
– Mesa owes $10 as management fees.

How much Mesa portfolio worth?!

(7*100)+(31*10) = 700+310+1010
Calculate net value of the fund.
Total asset* - liabilities = 1010 – 10 = 1000
* In this example total asset = portfolio value because there is no cash or any other assets.
1.Open-End Mutual Fund
(Cont.) assume that Mesa has a total value
of five shares outstanding.
Calculate mutual fund share (Net asset
value) ?!

NAV = (1010-10) / 5 = $200

What is NAV ?!
Simply, how much each mutual fund
shareholder would receive if the fund
liquidated (sold) toady.

Fund asset : stocks value + cash ..etc.

Fund Liabilities : fees, expense ..etc.
Outstanding share : number of fund share (not the listed shares)
 (Cont.)
You give Mesa $200 to buy one share of their fund.
What shall Mesa do with the $200?! Buy stock from Dolezilek &
Hardy

What happen to number of outstanding shares ?!

The number of shares increase from 5 to 6.
After two weeks you decide to sell your one share. If the
NAV is $205. what going to happen next ?!
– Sell your shares for $205.
– Receive your money $205.
– Number of outstanding share will fall from 6 to 5.
 Problem Page 570

You have been recently hired at a mutual fund. The

fund had 400 mutual fund shares outstanding, held
$210 in cash, has accrued a management fee of $40.
The fund hold the following stocks :

Stock No. of Price

Shares
Phil’s firefighting 100 $15
Terri’s 50 $30
Mary’s Travel 220 $12
Mike’s Baseball 30 $45
Problem Page 570

What is the NAV ?!

Total assets = portfolio value + cash = 6990+210 =

$7200
Fund value = Assets – liabilities = 7200-40 = $7160
NAV = 7160 / 400 = $17.9
Problem Page 570

if an investor redeems 2 shares,

How much he will receive ?!
2 * $17.9 = $35.8
What happen to the NAV ?!
(7160 – 35.8) / 398* = $17.9
The NAV wont change

* 398 because 2 shares redeemed

Types of Mutual Funds
Types of Mutual Funds (open-end)
1.Equity Funds
2.Bonds Funds
3.Hybrid Funds
4.Money Market Funds
Equity Funds
Invest primarily in stocks.
There are many type of equity funds.
1.Growth & Income Funds:
– Seeking capital gain & current income.
• Try to seek balanced return
– High quality common stock. (stable
performance)
Equity Funds
2. Aggressive Growth Fund
– Speculative funds, looking for capital gain.
– High P/E ratio
– Focus on small caps. (NOT apple, GE …etc)
– Highly volatile.
3. Growth Funds
– High growth high P/E ratio
– Also look for capital gain
– Pay no dividends (no current income).
– For aggressive investor with long-term horizons.
 Equity Funds
4. International & Global equity funds
– Invest outside the US or your country for many
reasons.
• Diversification.
• Tax consideration.
• Opportunities.
• Better investment environment.
– Investor must be aware of term & conditions.
5. Income-Equity Funds
– Investing in companies pay dividends (equity income).
– Preferable by mature and old people.
 Equity Funds
6. Index Funds
– New fashion in finance!
– Just follow the market index or specific index like
S&P500!
– Offer very low fees.
– Match the return from a particular index.

7. Specialized Funds
– Focus on specific sector.
Bond Funds
Invest primarily in Bonds.
There are many type of bond funds.
1.High yielding bonds
– Invest in junk bonds.
– High default risk, high yield. (low credit rating)
2.Corporate bond funds
– Investing in corporate bond.
– Rated by well known rating firms (Moody’s, Standard & Poor’s)
– Low default risk (high rating corporation)
Bond Funds
3. Government bonds fund
– Mainly invest in Gov. bonds
– .. and bonds issued by states, local gov. and
federal.

4. International & Global bond funds

– Also known as “World bond fund”.
– Invest in government & global bonds around the
world.
– Good option to diversify portfolio (especially for US investors)
Bond Funds
5. Strategic bond funds
– Hold combination of different type of bonds.
• Invest in government, corporate, municipal bonds
..etc.

6. Municipal Bond Funds

– Invest in bonds issued by states, local Gov. and
municipalities.
– Tax exempt (don’t pay tax).
Hybrid fund
Invest to stocks & bonds.
1.Balanced Funds
– Constant proportions ( ex. 60% stocks – 40%
bonds).
2.Asset Allocation Funds
– Include stocks and bonds (including cash).
– Weight depend on condition*.
– Use a computer to calculate risk & return.

* For example during recession, the portfolio will contain more bonds than
stocks
Money Market Mutual Fund
• Invest in money market securities
– T-bills, Repos, Banker acceptance, commercial papers,
Municipal notes, negotiable certificates of deposits.

• Short-term
– Less than one years.
• Very liquid
• Low risk
• Low return
 2.Closed-End Fund
Definition : A closed-end fund is a publicly traded
(listed) investment company that raises a fixed
amount of capital through an initial public
offering (IPO).

– The fund is then structured, listed and traded like a stock

on a stock exchange.
2.Closed-End Fund

Investors
John Fund

1.John fund sell shares for first time to investors

(IPO).
2.Investors bought shares.
3.John fund use money to invest in a financial
market.
4.John Fund shares will be listed in a stock market.
 2.Closed-End Fund
John sell 1000 share for $100.
After one year, John portfolio contain the following stocks.
The fund has no liability and no cash.

Calculate the net asset value ?!

Closed-End Fund also known as "closed-end investment" or "closed-end mutual fund.

 2.Closed-End Fund
• How can investor buy John shares ?!
From another investor (secondary market)
• What happen to number of outstanding shares?!
No change. Closed end fund shares are fixed.
What determine the price of Closed-end fund ?!
– Is it NAV OR supply & demand ?!

Answer: in closed end fund the price depend on Supply & demand because
its listed in the market, but NAV will be useful to determine the fair value
of the share. Opposite to open-end fund price determined by NAV.
3.Exchange Traded Fund (ETF)
Definition :
– is a marketable security (traded + listed)
– Follow (tracks) an index, a commodity, bonds,
or a basket of assets like an index fund.
– Charge low fees.
– Very liquid security.
3.Exchange Traded Fund (ETF)

Investors Smith
ETFs

1.Smith fund sell shares for first time to investors

(IPO).
2.Investors bought Smith’s ETFs (shares).
3.Exchange Traded Fund (ETF)
3.Smith fund use money to invest in a financial
market by following an index. For examples :
– Spiders : track the S&P 500 (largest 500 companies)
– Cubes : track the Nasdaq 100 (largest 100 companies)
– Diamonds : track the Dow Jones index.

4.Smith Fund shares will be listed in a stock market.

What determine ETF price?! Is it : NAV or Supply & Demand.
Answer : just like closed-end fund (refer to slide 30).
Creation & redemption ETFs
• Buying and selling ETFs and ..
• … creation & redemption.
• Example : An ETF consist of 50 share, the ETF
contain two stock only.
Company No.
Stocks
Caribou 100
High Tech. 50
Each share of ETF consist of 2 caribou stocks + 1 High tech.
stock
 Creation & redemption ETFs
What if an investor would like to redeem (sell) 1 ETF ?!
Option 1 : sell it directly in the stock exchange!
Option 2 :
1.Investor return the ETF share.
2.Then receive 2 caribou stocks & 1 High Tech. stock
3.Sell the stocks in the market.
Creation & redemption ETFs
What if an investor would like to create (buy) 1
ETF ?!
Option 1 : buy it directly from the stock exchange!
Option 2 :
1.Investor will buy 2 caribou stocks & 1 High Tech.
Stock.
2.Investor give the stocks to ETF.
3.Investor receive 1 ETF share.
ETF : Examples
For example if Rachel ETF contain 500 outstanding shares, the fund hold only 1000
PepsiCo. shares selling for $100.

Calculate NAV ?
What if Rachel ETF is selling for 205 ?!
How can investor get benefit from the arbitrage* ?!
Investor can buy two stocks of PepsiCo.
Convert the two stocks to 1 Rachel ETF.
Then sell Rachel ETF for $205.
Make profit = 205 – 200 = $5.

* Making profit with out facing risk!

4.Unit Investment Trust
• An investment company. 
• Offers a fixed, unmanaged portfolio, generally of stocks and bonds.

– No new securities bought or sold*.

• Redeemable "units" after a specific period of time.
• Designed to provide dividend income. 
• Can re-sold in the secondary market.

Investors UNIT
Investment
Trust

* With rare exception.

Real estate investment trust (REIT)

A fund similar to closed-end fund.

Invest in real estates (houses, building ..etc)

Hold income-generating properties.

Listed in stock exchange.

Investors
REIT
 End of chapter 19

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ublished by www.Kingsoftstore.com @Kingsoft_Office

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Exercise one
 
Invest only technology sector.
 
Riskiest equity fund.
 
Invest in government & global bonds around the world for
many reasons. (diversification, tax consideration …etc)
 
Hold combination of different type of bonds.
 
Buying stocks in line with index weight or any other index.
 
A portfolio contain Batelco. shares & Bond issued by
Bahrain Gov.
 
Invest in government bonds.
 
A portfolio contain T-bills, commercial papers, BA & Repos.
 
Invest in bonds issued by states, local gov. and
municipalities.
 
Bonds with high default risk. (low credit rating)
 
For investor seeking dividends.
 
Good rating bond with low default risk.
 
Seeking both capital gain & dividends.
 Exercise 2
      ETFs Unit REIT
Open-end Closed-end investment Real estates
Exchange Investment
Traded Fund trust Trust

Main
investment

Main
Feature

Buying/Sell
ing

Listed

How to
price
       ETFs Unit REIT
Open-end Closed-end investment Real estates
Exchange Investment
Traded Fund trust Trust
Main  Stocks Stocks 1.Stocks Bonds:Corp.Muni Any
investment & Bonds & Bonds  2. Bonds &Gov. Investmen
3. Prefarred stock t related to
Commodity  MM Securities. Real-
estate 
Main  # of shares is # of shares  follow index Unmanaged  provide
Feature unlimited is limited Well diversified Liquidate after income
  (fixed) Low fees Specific
  period 
Buying/Sell From fund  Secondary   Secondary Secondary  Secondary
ing Fund    
Listed NO Yes YES Yes  Yes 

How to NAV  Supply & Supply & Supply & Supply &
price Demand  Demand  Demand  Demand 
 Exercise 2
Let's assume at the close of trading yesterday that a
particular mutual fund held $1,050,000 worth of
securities, $200,000 of cash, and $50,000 of
liabilities. If the fund had 100,000 shares outstanding,
then yesterday's NAV would be:
Answers :

(1,050,000 + 200,000 – 50,000) / 100,000 = $12

 Exercise 2
SRI ETFs contain 1000 share, their portfolio consist of
4000 DE stock selling for $15 and 1000 stock of
Sigma selling for $22. If SRI ETFs selling for $85. How
can investor get advantage from this difference.

What if SRI ETFs were selling for $80. Still arbitrage ?!

Buy 4 stock of DE + 1 stock of sigma = 82
Provide the stock for SRI fund
SRI issue new ETF
Sell it for $85!
 Exercise 2
What if SRI ETFs were selling for $80. Still arbitrage ?!
Buy SRI ETF from the market.
Redeem the SRI ETF to the fund
Receive 4 stock of DE + 1 stock of sigma
Sell the stocks for 82!
 Exercise 2
If the ETF stock price is lower than NAV :

a. ETF is trading at a discount to its underlying

value.
b. ETF is trading at a fair price to its underlying
value.
c. ETF is trading at a premium to its underlying
value.

Answer is A, since ETF is trading less than NAV (the fair price) that mean ETF
worth more than the current price.
Exercise 2
Which type of fund represent largest share
of investment companies ?!
a. Open-end fund.
b. Closed-end.
c. Exchange traded fund (ETFs).
d. Real estate’s investment trust.

Answer : A
 Exercise 2
Sam bought Cubes ETFs, which track the largest 100
listed companies in Nasdaq-100 index. After a year
Nasdaq-100 increase by 7.2%. Sam expect to make :
a. 7.2% exactly because he hold the same stocks.
b. Slightly lower than 7.2% because of fees paid to
the fund.
c. Can’t determine because Sam might invest in the
same stocks but in different weight.
ETFs simply have the same stock for a specific index,
so the return for ETF will match the index performance
But it will be bit lower than index return because of the
Paid fees. Answer is B.
 Exercise 2
Which of the following represent ETFs feature/s:
a. Charge low fees. Because selection criteria is easy.

b. Well diversified. Contain many stocks

c. Listed in the stock market. just like any stock, Batelco.
Apple ..etc.

d. All of the above.

Answer is D.
 Exercise 2
he said “once the manager bought the portfolio stocks
it will never be changed, and the fund will be
liquidated after 10 years..”, he added “.. BUT you can
sell your shares in the secondary market. This type of
fund illustrate :
a. ETFs.
b. Closed-end fund.
c. Unit investment trust.
d. A real estate investment trust.

Answer is C refer to Unit investment trust features.

 Exercise 2
Secure Investment Fund change their stock and bond
weight over time as market condition change. This type
of fund illustrate :
a. Money Market Mutual fund. stock & bond is not Money Market
securities.

b. Asset allocation Fund.

c. Bond Fund. Invest in BOND only!

d. ETFs. Weight according tracked index

Answer is B.
 Exercise 2
A mutual fund allowing both small and large investors
to acquire ownership in real estate ventures, and pay
annual income from holding investment.
a. ETFs.
b. Closed-end fund.
c. Unit investment trust.
d. A real estate investment trust

Answer is D.