Chapter 3

Charles P. Jones, Investments: Analysis and Management,

12th Edition, John Wiley & Sons

3-1
 Alternative to direct investment in or
ownership of securities
◦ Accomplishes essentially the same thing as direct
investing
 Refers to buying and selling the shares of
intermediaries that hold securities in portfolio
◦ Shares are ownership interest in portfolio entitled
to portfolio income
◦ Shareholders also pay expenses and management
fee

3-2
 Firm that sells shares to the public and uses
the proceeds to invest in marketable
securities
◦ Acts as conduit for distribution of dividends,
interest, and realized gains
◦ Offers professional management
◦ Regulated but not insured or guaranteed by any
federal agency
◦ Shareholders pay taxes as if they directly owned
securities

3-3
 Unit Investment Trust (UIT)
◦ Typically holds an unmanaged, fixed-income
portfolio
◦ Relatively small share of market
 Closed-End Investment Company
◦ Actively managed portfolio
◦ Fixed number of shares
◦ Trade on stock exchanges like other stocks

3-4
 Exchange Traded Funds
◦ Portfolio of assets that tracks a sector, region, or
market
◦ Trade like individual equities on exchange
◦ Management fees low
 Typically unmanaged portfolios
◦ Tax efficiency
 Investor has greater control over realization of capital
gains/losses than with a mutual fund

3-5
 Mutual Funds (Open-end Investment
Companies)
◦ Investors buy fund shares from investment
companies, sell shares back to those companies
 Mutual funds not sold on exchanges
◦ Number of shares outstanding constantly changing
(unlike closed-end funds)
◦ Offer diversification, professional management,
other services
◦ Popular with investors, especially in retirement
plans

3-6
 Money Market Funds (MMFs)
◦ Invest in portfolio of money market securities
◦ Taxable or tax-exempt
◦ Investors pay a management fee but not a sales or
redemption charge (load)
◦ Not insured by the federal government
◦ Attempt to keep price at $1/share
◦ Offer investors broad diversification, great liquidity
and a way to earn going money market rate

3-7
 Equity, bond, and hybrid mutual funds
◦ Equity funds hold primarily stocks, bond funds
primarily hold bonds and hybrid funds hold a
combination
◦ All invest in portfolio of securities consistent with
the objectives of the fund
◦ Company’s board sets objects, must specify them
in investment policy
◦ Objectives can be achieved in various ways, so
investment style can also be important

3-8
 Most equity funds are either:
◦ Value funds, which invest in stocks that are cheap
according to standard financial analysis methods
◦ Growth funds, which invest in stocks of firms
expected to show future rapid earnings growth
 These fund types tend to perform well at
different times, appeal to investors with
different objectives
 Best strategy is probably to hold both fund

types

3-9
Index Funds
 Mutual Funds designed to match a market
index
 Unmanaged portfolio, typically with low

expense ratio
◦ Expenses vary widely, though, so investors need to
be sure expenses are reasonable
 Often outperform actively managed mutual
funds

3-
10
Net Asset Value Per Share (NAV)
 NAV is per share value of securities in a fund
 Is the total market value of securities, minus

any liabilities, divided by number of shares

outstanding
 Changes daily and is calculated daily after

markets close at 4 p.m.

 If no sales charges, NAV is price investors pay

to buy mutual fund or price paid to investors

selling fund

3-
11
The Details of Indirect Investing
 Closed-end funds
◦ Market prices often differ from NAV
◦ Market price may be less than NAV (discount) or
more than NAV (premium)
◦ Portfolio’s return calculated based on NAVs
◦ Shareholder’s return calculated based on closing
prices
 Individual investors should avoid purchasing
newly offered shares of closed-end funds

3-
12
The Details of Indirect Investing
 Mutual Funds
◦ Investors can purchase directly or indirectly
◦ Usually only require a small minimum investment
◦ Investors can redeem shares anytime
◦ Investors purchase/redeem at NAV plus or minus
sales charges
◦ Fund’s prospectus discloses fees and expenses
 Load funds charge a sales fee
 No-load funds do not charge a sales fee

3-
13
The Details of Indirect Investing
 Mutual Fund Share Classes
◦ Way to give investors choice over fees
◦ Each class has same claim on portfolio, same NAV
 No-load funds
◦ Purchased at NAV directly from the investment
company
◦ No sales force expense to cover
◦ Investors must seek out funds
◦ Annual operating expenses paid out of fund income
 All funds charge shareholders an expense
ratio

3-
14
The Details of Indirect Investing
 Exchange-Traded Funds
◦ Can be bought or sold anytime during the trading
day
◦ Can be bought on margin or sold short
◦ Have much lower expenses than actively managed
funds
◦ Can weight indexes differently, which can affect
return

3-
15
 Reported on a regular basis in the popular
press
 Price performance not the same as total return
◦ Total return measures both price changes and
income (from dividends) over a specified time period
◦ Average annual return is a hypothetical measure
 Costs and taxes should also be considered
 Expenses may be the best indicator of a fund’s
performance

3-
16
 Some mutual funds specialize in international
securities
◦ Can have higher costs
◦ International funds or global funds emphasize
international stocks
◦ Single-country funds concentrate on one country
◦ Some ETFs match foreign indexes
 Not hedged against currency risk

3-
17
The Future of Indirect Investing
 Mutual fund “supermarkets”
◦ Investors can buy/sell funds from various mutual
fund families through a single source
◦ Offer fee and no-fee “aisles”
 Hedge Funds
◦ Largely unregulated investment companies
available to private investors
 May use leverage, derivatives, other strategies not
available to mutual fund managers
 Require substantial initial investment, charge
substantial fees

3-
18
Copyright 2013 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this
work beyond that permitted in section 117 of the 1976
United States Copyright Act without express
permission of the copyright owner is unlawful. Request
for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own
use only and not for distribution or resale. The
Publisher assumes no responsibility for errors,
omissions, or damages caused by the use of these
programs or from the use of the information herein.

3-
19