Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 1 Chapters 4 & 5 Mutual Funds and Other Investment Companies Investors and the Investment Process

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 2 Services of Investment Companies Administration & record keeping Diversification & divisibility Professional management Reduced transaction costs

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 3 Net Asset Value Used as a basis for valuation of investment company shares –Selling new shares –Redeeming existing shares Calculation Market Value of Assets - Liabilities Shares Outstanding

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 4 Types of Investment Organizations Unit Trusts Managed Investment Companies –Open-End –Closed-End Other investment organizations –Commingled funds –REITs

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 5 Open-End and Closed-End Funds: Key Differences Shares Outstanding Closed-end: no change unless new stock is offered Open-end: changes when new shares are sold or old shares are redeemed Pricing Open-end: Net Asset Value(NAV) Closed-end: Premium or discount to NAV

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 6 Investment Policies Money Market Fixed Income Equity Balance & Income Asset Allocation Indexed Specialized Sector

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 7 Sources of Information on Mutual Funds Wiesenberger’s Investment Companies Morningstar Investment Company Institute Popular press Investment services

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 8 Overview of the Investment Process Specify objectives Identify constraints Formulate an investment policy Monitor performance Reevaluate and modify portfolio as determined from monitoring

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 9 Specifying Objectives: Individual Investors Balance risk and return Life Cycle is critical to the process of determining the risk/return trade-off Younger investors - willing to bear more risk for higher returns Older investors - willing to accept lower returns for lower risk

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 10 Specifying Objectives: Personal Trusts and Mutual Funds Personal Trusts –Determined by the individual for whom the funds are being managed Mutual Funds –Varies with type of fund –Detailed in the prospectus

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 11 Specifying Objectives: Pension Funds and Endowments Pension Funds –Defined contribution - shifted to the individual –Defined benefit - depends on average time to retirement of individuals Endowment Funds –Gifts to nonprofits are invested –Funds from the endowment used by the nonprofit

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 12 Specifying Objectives: Insurance Companies Life Companies –Investments are hedged against potential claims of policy holders Non-Life Companies –Invest premiums not paid back to policyholders for loss –Hedge against potential claims

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 13 Specify Objectives: Banks Sources of funds: deposits and borrowed funds Investment of funds: predominately in loans and fixed income securities Active in the securitized loan and asset markets Not active in equity except in the Trust Function

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 14 Investor Constraints Liquidity - speed and ease with which as asset can be converted into cash Investment Horizon - the planned liquidation date Regulations - specific regulations that may apply to the investor Prudent Man Rule Mutual Fund Diversification Charitable contribution limits

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 15 Investor Constraints Tax Considerations - special considerations related to tax position of the investor Unique Needs- special considerations related to the underlying investors Diversification requirements related to employment

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 16 Investment Policy: Asset Allocation Decision Individual - depends on life cycle Younger Higher equity 75% Lower safe assets 25% Older Lower equity 40% Higher safe assets 60% Institutional - depends on objectives Example - an all stock mutual fund would want nearly 100% in stock Sector or Region allocations

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 17 Investment Policy: Active or Passive Active Trying to secure better than average performance Must balance returns and costs Passive Trying to get average returns rather than do better than the market Mix of Passive and Active

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 18 Taxes and Investment Strategy Shelter Options Deferral of taxes on capital gains Tax Deferred Retirement Plan –IRA –401(k) –Taxes are paid on the income from retirement and not on returns from investment