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LOS a: Differentiate between an open-end and a closed-end fund, and explain how net asset value of a fund is calculated and the nature of fees charged by investment companies.

An investor is contemplating buying a load fund versus a no load mutual fund. She is trying to figure out the actual amount she will have to spend on the load fund. The shares have a net asset value (NAV) of $34.50 and a load of 5.2%. Determine which type of fund will always have a share price equal to the NAV and the price she will pay for the load fund.

The share price of an open-end fund will always equal the NAV, since the investment company is obligated to redeem shares at any time at current market value.

Offering price = $34.50 / (1 – 0.052) = $36.39.

Based on the following information, what is the net asset value (NAV) per share. There are currently no expenses and no load.

Total number of shares sold = $109,000 = 10,900 shares

$10 (per shares)

Total market value
= 1,051 × 10 = 10,510

2,420 × 35 = 84,700

1,851 × 9 = 16,659

900 × 69 = 62,100

173,969

NAV
= 173,969 = 15.96 per share

10,900

A sales commission charged by an investment company at the time of redemption is called a:

A front-end load is a sales commission charged at purchase. A distribution fee, also called a 12b-1 fee, is an ongoing fee, charged on an annual basis as a percentage of assets, which is used to cover any marketing expenses incurred by the management company. A charge to exit a fund is called a back-end load or a redemption fee.

Bill Lynch, CFA, is a branch manager for a brokerage firm. He is reviewing a set of slides for a sales presentation that one of his subordinates will deliver next week. In a section that explains the nature of the various fees charged by investment companies, Lynch finds slides that state the following:

Slide 8: Fees charged by investment companies are a trade-off from the investor’s point of view. Lower fees will subtract less from the investor’s rate of return, but higher fees give portfolio managers greater incentives to achieve higher returns.

Slide 12: When choosing between a fund’s share classes, the investor should select the class with the lowest total annual fees.

Lynch should disagree with both of these statements. Premiums, loads, and redemption fees are compensation for sales and marketing efforts, but they are not performance incentives for the portfolio managers. Different classes of shares can be structured with different schedules of front-end, back-end, and distribution fees. The optimal choice depends on the investor’s expected holding period and is not necessarily the one with the lowest total annual fees.

The net asset value of a closed-end mutual fund is $11.20, and the share price is $10.00. The discount or premium is closest to:

(SP - NAV) / NAV =

(10.00 - 11.20) / 11.20 = ?0.107

Jillian Best is choosing between two mutual funds. Fund A has a front-end load of 4%, a net asset value (NAV) of $60.00, and an expected return of 13.0%. Fund B has a redemption fee of 1.5%, a NAV of $27, and an expected return of 10%. Jillian will invest $50,000 in either fund. Which of the following statements is most accurate if Jillian has a 6-month holding period? The:

A)	investor is better off with the front-end load fund by $120.00.

B)	investor is better off with the redemption fee fund by $712.50.

C)	investor is better off with the redemption fee fund by $592.50.

Front end load fund:

$50,000 (1 – 0.04)(1.065)

= $51,120.00

Redemption fee fund:

$50,000 (1.05)(1 – 0.015)

= $51,712.50

Redemption fee fund advantage

$ 592.50

Which of the following statements about investment companies is least accurate?

A)	The investment company's board of directors hires an investment management company to select securities, manage the portfolio, and handle administrative duties.

B)	Investment companies are generally wholly owned subsidiaries of the investment advisory firm that creates them.

C)	Generally the investment advisory firm initiating the fund will also act as the fund's investment management company.

Investment companies are owned by individual investors. For example, individuals who purchase shares in a mutual fund are the "owners" of that fund.

You are going to invest in a closed-end mutual fund and are told that the net asset value of the fund is $20.40, and the share price is $18.20. What is the discount you would receive or the premium that you would pay?

A)	market value of assets minus liabilities divided by the number of shares outstanding.

B)	book value of all assets divided by the number of shares outstanding.

C)	supply and demand for the shares in the investment management company.

An investment company that stands ready to redeem investor shares at market value is classified as:

A)	a closed-end investment company.

B)	an open-end investment company.

C)	a managed investment company.

A closed-end investment company does not redeem investor shares; after issuance, shares trade in the secondary market. Some managed investment companies may redeem shares, but others may not. An open-end investment company always offers a redemption feature.

A)	a front-end load.

B)	a premium to the underlying net asset value (NAV).

C)	an annual management fee.

Both types of managed funds, open-end and closed-end, typically charge an annual management fee. Open-end funds sometimes charge a front-end load or a redemption fee, but closed-end funds do not. Closed-end funds can sell at a premium (or discount) to underlying NAV, but this does not result in compensation to the fund.

A)	is determined in the secondary market.

B)	may or may not equal NAV.

C)	always equals NAV.

Shares of a closed-end investment company are determined in the secondary market and may or may not equal NAV. Share value of an open-end investment company always equals NAV because the investment company stands ready to redeem shares at their net asset value.

The per-share value of an investment company’s assets minus its liabilities is called the:

The net asset value (NAV) of an investment company is calculated as assets minus liabilities, stated on a per-share basis.

A)	The redemption fee for a closed-end fund is the commission charged on the sale and a portion of the bid/ask spread of the shares.

B)	The liquidity of an open-end fund is provided by the open market.

C)	Some open-end funds charge no fees.

Since closed-end funds are traded in the secondary market for a price determined by supply and demand for shares, the spread along with the sales commission represent the redemption fee. All funds charge fees, although the fees vary widely from fund to fund. In addition, some funds charge a load in addition to fees. The liquidity of an open-end fund is provided by the company that manages it, not the open market.

A)	must register a maximum number of shares with the Securities and Exchange Commission (SEC).

B)	must redeem shares at the net asset value with no fees included.

C)	can continue to sell and repurchase shares after their initial public offerings.

The primary difference between open-end and closed-end funds is that open-end funds continue to sell and repurchase shares after their initial public offerings. Open-end investment companies can be load or no-load.

A)	has its price determined by the net asset value (NAV).

B)	has its price determined by supply and demand, regardless of its net asset value (NAV).

C)	is traded in the primary market but not the secondary market.

Closed-end investment companies are initiated through a stock offering to raise funds. The investment company does not issue or redeem shares after the initial offering. Shares of a closed-end investment company are traded in public markets and are priced by supply and demand. The share price of a closed-end fund is not directly linked to the fund’s NAV. The NAV is the prevailing market value of all the shares and assets owned by the fund. Many closed-end funds sell at a discount of 5 to 20% from their NAV.

Cap Stock Sold $109,000
Price per share $10
Stock	Shares	Price	Book Value
A	1,051	$10	$5
B	2,420	$35	$29
C	1,851	$9	$8
D	900	$69	$63

Total number of shares sold	=	$109,000	=	10,900 shares
Total number of shares sold	=	$10 (per shares)	=	10,900 shares

Total market value	=	1,051 × 10	=	10,510
		2,420 × 35	=	84,700
		1,851 × 9	=	16,659
		900 × 69	=	62,100
				173,969

NAV	=	173,969	=	15.96 per share
NAV	=	10,900	=	15.96 per share

Front end load fund:	$50,000 (1 – 0.04)(1.065)	= $51,120.00
Redemption fee fund:	$50,000 (1.05)(1 – 0.015)	= $51,712.50
Redemption fee fund advantage		$ 592.50