ANSWERS TO CONCEPT QUESTIONS, FINANCIAL PLANNING PROBLEMS AND QUESTIONS AND CASES

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ANSWERS TO CONCEPT QUESTIONS, FINANCIAL PLANNING PROBLEMS


AND QUESTIONS AND CASES

CONCEPT QUESTIONS

Concept Check 13
-
1 (p. 362)

1.

In what ways could mutual funds help you obtain your investment goals?

While each student must answer this questi
on, you may want to use the question to reinforce
the fact that the major reasons why investors purchase mutual funds are professional
management and diversification. (pp. 356
-
357)


2.

Closed end, exchange
-
traded, or open ended mutual funds are available t
oday. Describe the
differences between each type of fund.

A closed
-
end fund is a mutual fund whose shares are issued by an investment company only
when the fund is organized. After all the shares originally issued have been sold, an investor
can purchase
shares only from another investor who is willing to sell them. An exchange
-
traded fund (ETF) is a fund that invests in the stocks contained in a specific stock index.
Although most closed
-
end funds are actively managed, ETF managers are more passive.
Share
s for both closed
-
end and exchange
-
trade funds are traded on organized exchanges or in
the over
-
the
-
counter market. An open
-
end fund is a mutual fund whose shares are issued and
redeemed by the investment company at the request of investors. Investors are
free to buy and
sell shares at the net asset value. (pp. 358)


3.

What is the net asset value (NAV) for a mutual fund that has assets totaling $365 million,
liabilities totaling $5 million, and 12 million shares outstanding? (p.358)

The net asset value (N
AV) is $30

$365 million (assets)
-

$5 million (liabilities) = $360 million

$360 million ÷ 12,000,000 (shares) = $30


4.

In the table below, indicate the typical charges for each type of mutual fund fee and how the
fee is assessed. (pp. 359
-
362)


Fee

Typica
l Charge

How Often Assessed?

Front
-
end sales load



Contingent deferred sales load



Management fee



12b
-
1 fee



Fee

Typical Charge

How Often Assessed?

Front
-
end sales load

Up to 8½ percent of the purchase

When shares are purchased

Contingent defe
rred sales load

1 to 5 percent of withdrawal
amount depending on how long
you own shares before making a
withdrawal

Usually the fee is charged when
investor withdraws money during
the first five years

Management fee

0.25 to 2 percent per year

A predetermi
ned date each year

12b
-
1 fee

Approximately 1 percent a year

Once a year


5.

What is an expense ratio? Why is it important?

An expense ratio is the amount that investors pay for all of a mutual fund’s management fees
and operating costs. It is important

because it is an ongoing fee

year after year. Many
financial planners recommend that you choose a mutual fund with an expense ratio of 1
percent or less. (p. 360)

Concept Check 13
-
2 (p. 365)

1.

How important is the investment objective as stated in the

fund’s prospectus?

The managers of mutual funds tailor their investment portfolios to the investment objectives
of their customers. As such, investors must make sure that their objectives and a prospective
mutual fund’s objectives match. While discussing

the answer to this question, you may want
to review the objective for the Fundamental Investors Mutual Fund in this section. (p. 363)


2.

Identify one mutual fund in each of the three categories (stocks, bonds, and other) and
describe the characteristics

of the fund you select and the type of investor who would invest
in that type of fund.

General Fund Type

Specific Fund Type

Characteristics of
Fund

Typical Investor

Stock




Bond




Other





Depending on the fund each student chooses for each general

type, student answers will vary.
Still you can use this question to reinforce the concept that fund managers know that
investors have different objectives, and therefore, offer funds to match those objectives. You
may also want to review the major types

of funds described in this section and point out why
some funds may be a good choice for one investor and a poor choice for another. (pp. 363
-
364)


3.

Explain the family of funds concept? How is it related to shareholder exchanges?

A family of funds exi
sts when one investment company manages a group of mutual funds.
Each fund within the family has a different financial objective. Generally, investors may give
instructions to switch from one fund to another within the same family. (pp. 364
-
365)

Concept Ch
eck 13
-
3 (p. 374)

1.

In your own words, describe the difference between a managed fund and an index fund.
Which one do you think could help you achieve your investment goals?

Most mutual funds are managed funds. There is a professional fund manager (or t
eam of
managers) that chooses the securities that are contained in the fund. The fund manager also
decides when to buy and sell securities in the fund. Instead of investing in a managed fund,
some investors choose to invest in an index fund. Over many y
ears, index funds have
outperformed almost 85 percent of all managed funds. Simply put: It’s hard to beat an index.
Students must decide which type of fund is best? The answer depends on which managed
fund they choose. If they pick a managed fund that

has better performance than an index,
then they made the right choice. If on the other hand, the index (and the index fund)
outperforms the managed fund

which happens almost 85 percent of the time

an index
fund is a better choice. (pp. 365
-
368)


2.

Assu
me you are considering a $5,000 investment in a growth mutual fund. How would you
go about researching your potential mutual fund investment?

Because of technology available today, most investors would begin the search for a mutual
fund by getting online.

The Internet

can provide investors with current market values,
information about the fund provided by the investment company sponsoring the fund, and by
professional advisory services. Once possible mutual funds that match the investors goals are
identi
fied, many investors would then turn to professional advisory services. Professional
advisory services provide investors with the most detailed information about mutual funds.
Investors can also request a prospectus and an annual report from the investme
nt company
that manages the fund. (pp. 368
-
374)


3.

Describe how each of the following sources of investment information could help evaluate a
mutual fund investment.


Source of Information

Type of Information

How This Could Help

The Internet



Profes
sional advisory services



Mutual fund prospectus



Mutual fund annual report



Financial publications



Newspapers




A lot of information is available to help investors evaluate mutual funds. The
Internet
can
provide investors with current market v
alues, information about the fund provided by the
investment company sponsoring the fund, and by professional advisory services.
Professional advisory services

provide investors with the most detailed information about
mutual funds. The
mutual fund

prosp
ectus

contains a summary of the fund and information
about fees, past financial performance, and the fund’s management. The
mutual fund annual
report

also contains detailed financial information on the fund’s assets and liabilities,
statement of operations
, and statement of changes in net asset value. The annual report also
contains a schedule of investments and a letter from the fund’s independent auditors.
Financial publications

provide investors with another detailed source of information about
mutual fu
nds.
Newspapers
provide current information about a mutual fund’s net asset value,
change in net asset value, and performance. (pp. 368
-
374)


Concept Check 13
-
4 (p. 379
)

1.

In your own words, describe the advantages and disadvantages of mutual fund investm
ents.

There are many advantages that encourage investors to choose mutual funds. Unfortunately,
there are also disadvantages. While reviewing this question with your students, you may
want to examine Exhibit 13
-
8 on p. 375. (pp. 374
-
375)


2.

In the tab
le below indicate how each of the key terms affects a mutual fund investment and
how each would be taxed.

Key Term

Effect on a Mutual fund
Investment

Type of Taxation

Income dividends



Capital gain distributions



Capital gains



Capital losses




Income dividends

are the earnings a fund pays to shareholders from its dividend and interest
income and are taxed as regular (ordinary) income.
Capital gain distributions

are the
payments made to a fund’s shareholders that result from the sale of securitie
s in the fund’s
portfolio. A
capital gain

results when a shareholder decides to sell shares in a mutual fund at
a price that is higher than the price paid for the shares. A
capital loss
results when a
shareholder decides to sell shares in a mutual fund at

a price that is lower than the price paid
for the shares. Capital gain distributions, capital gains, and capital losses are reported on
Schedule D as part of your federal tax return and on the Form 1040. Note: Capital gains and
capital losses can be ta
xed as either a short
-
term or long
-
term capital gain. (p. 377)


3.

Whom would you contact to purchase a closed
-
end fund? An exchange
-
traded fund?

Shares of a closed
-
end and exchange
-
traded funds are traded through the New York Stock
Exchange, through var
ious other stock exchanges, or in the over
-
the
-
counter market. (p. 377)


4.

What options can be used to purchase shares in an open
-
end mutual fund from an investment
company?

The shares of an open
-
end fund may be purchased through a salesperson who is aut
horized to
sell them, through an account executive of a brokerage firm, through a mutual fund
supermarket, or directly from the investment company. To purchase shares from an
investment company, investors may use these options: regular account transactions
, voluntary
savings plans, contractual savings plans, and reinvestment plans. (pp. 377
-
378)


5.

What options can you use to withdraw money from a mutual fund?

Because closed
-
end and exchange
-
traded funds are listed on securities exchanges or in the
over
-
th
e
-
counter market, it is possible to sell shares in such a fund to another investor. Shares
in an open
-
end fund can be sold on any business day to the investment company that sponsors
the fund. Investors may also use these options to withdraw funds: (1) wit
hdraw a specified,
fixed dollar amount each investment period; (2) liquidate or sell off a certain number of
shares each investment period; (3) withdraw a fixed percentage of asset growth; and (4)
withdraw all income that results from income, dividends, an
d capital gains earned by the fund
during an investment period. (pp. 378
-
379)

PROBLEMS AND QUESTIONS

1.

Given the information below, calculate the net asset value for the Boston Equity mutual fund.

Total assets

$225,000,000

Total liabilities

5,000,000

T
otal number of shares

4,400,000

The net asset value per share is equal to the current market value of the mutual fund’s
portfolio minus the mutual fund’s liabilities divided by the number of shares outstanding. For
the above information, the net asset val
ue is $50 as calculated below. (p. 358)

Net asset value =
000
,
400
,
4
000
,
000
,
5
$
000
,
000
,
225
$


Net asset value = $50 per share


2.

Jan Throng invested $15,000 in the Aim Charter Mutual Fund. The fund charges a 5.50
percent commission when shares are purchased. Calculat
e the amount of commission that Jan
must pay .Ms. Throng must pay $825 for commissions as illustrated below. (p. 359)

5.5% = 0.055

$825 Commission = $15,000


0.055


3.

Mary Canfield purchased the New Dimensions bond fund. This fund d
oesn’t charge a front
-
end load, but it does charge a contingent deferred sales fee of 4 percent for any withdrawals
for the first five years. If Mary withdraws $6,000 during the second year, how much is the
contingent deferred sales fee?

Ms. Canfield must
pay a $240 contingent deferred sales fee, as illustrated below. (pp. 359
-
360)

4% = 0.04

$240 = $6,000


0.04


4.

Mike Jackson invested a total of $8,500 in ABC mutual fund. The management fee for this
particular fund is 0.70 percent o
f the total asset value. Calculate the management fee that
Mike must pay this year.

Mr. Jackson must pay a $59.50 management fee this year. (p. 360)

0.70% = 0.0070

$8,500 total investment


0.0070 = $59.50 management fee


5.

This ch
apter explored a number of different classifications of mutual funds.

a.

Based on your age and current financial situation, which type of mutual fund seems
appropriate for your investment needs? Explain your answer.

b.

As people get closer to retirement t
heir investment goals often change. Assume that you
are now 45 and have accumulated $110,000 in a retirement account. In this situation,
what type of mutual fund would you choose? Why?

c.

Assume that you are now 60 years of age and have accumulated $400,00
0 in a retirement
account. Also, assume that you would like to retire when you are 65. What type of mutual
funds would you choose to help obtain your investment goals? Why?

a.

Student answers will vary depending on their age and investment philosophy. For
som
eone in their twenties, investments should provide the type of long
-
term growth
possibilities that will enable them to grow their retirement nest egg over a long period of
time.

b.

As people get older, they tend to choose more conservative investments. Since
most
people don’t retire until they are 60 to 65, you still have a number of years for your
investments to appreciate. Perhaps conservative mutual funds that emphasize both growth
and income could be chosen.

c.

The fact that you are now 60 should be taken int
o consideration. More conservative
mutual funds that emphasize preservation of capital and predictable sources of income
are a wise choice for people who are near retirement age. While it is still desirable to
have some growth component in their portfolio,

investors tend to be concerned with
safety. (pp. 363
-
365)


6.

Choose either the Aim Charter (symbol CHTRX) mutual fund or the Aim Basic Value
(Symbol GTVLX) mutual fund. Then describe how each source of information could help
you evaluate one of these mu
tual funds.

a.

The Internet

b.

Professional advisory services

c.

The fund’s prospectus

d.

The fund’s annual report

e.

Financial publications

f.

Newspapers

Student answers will vary depending on which AIM fund your students chose. (pp. 368
-
374)

a.

The
Internet

can pro
vide current market values for mutual funds, access to the home
page provided by the investment company sponsoring a mutual fund, and online research
reports provided by professional advisory services.

b.

Professional advisory services

like Standard & Poo
r’s, Lipper Analytical Services,
Morningstar, Inc., and Value Line provide detailed financial information that can be used
to evaluate mutual funds.

c.

The fund’s
prospectus
for a mutual fund is available to prospective investors and
contains a fee table a
nd other information that can be used to evaluate a mutual fund
investment.

d.

The fund’s
annual report

contains detailed financial information on the fund’s assets
and liabilities, statement of operations, and statement of changes in net asset value. It
s
hould also include a schedule of investments and a letter from the fund’s independent
auditors.

e.

Financial publications

like
Business Week
,
Forbes
,
Kiplinger’s Personal Finance
Magazine
,
Money
and other investor
-
oriented magazines provide information on
the
performance of many mutual funds.

f.

Newspapers

report current information on a mutual fund’s net asset value and change in
net asset value on a daily basis. Many newspapers also offer information on a fund’s past
performance.


7.

Visit the Yahoo Finan
ce Web site and evaluate one of the mutual funds listed below. To
complete this activity, follow these steps.

a.

Go to http://finance.yahoo.com.

b.

Choose one of the three funds, enter its symbol, and click on the
“go”

button.


Fund Name

Fund Ticker Symbo
l

Oakmark Fund I

OAKMX

Scudder Growth A Fund

KGRAX

Washington Mutual A Fund

AWSHX


c.

Print out the information for the mutual fund that you chose to evaluate.

d.

Based on the information included in this research report, would you invest in this fund?

Explain your answer.

While student answers will vary, you may want to use this question to stress the importance
of evaluating any mutual fund investment. In addition to the Internet, the other sources of
information discussed in this chapter could help i
n the evaluation process (pp.368
-
374)


8.

Assume that one year ago you bought 100 shares of a mutual fund for $15 per share, you
received a $0.75 per share capital gain distribution during the past 12 months, and that the
market value of the fund is now $1
8.

a.

Calculate the total return for your $1,500 investment.

b.

Calculate the percentage of return for your $1,500 investment.

a.

The total return is $375. (pp. 375
-
376)

(1) Current return = $0.75


100 shares = $75

(2) Future re
turn = $1,800 sales price
-

$1,500 purchase price = $300

(3) Total return = $75 current return + $300.00 future return = $375

b.

The percentage of return is 25% (p. 376)

Dollar amount of total return ÷ Original cost of your investment = Percentage of tota
l
return

$375 ÷ $1,500 = 0.25 = 25%

9.

Obtain a mutual fund prospectus to determine the options you can use to purchase and
redeem shares.

a.

Which of the purchase options would appeal to you? Why?

b.

Assuming that you are now retirement age, which withdrawal

options would appeal to
you?

Answers for the above questions will vary depending on the mutual fund chosen by the
student. And yet, most mutual funds offer the following options for purchasing shares:
regular accounts, voluntary savings plans, contractual

savings plans, and reinvestment
plans. Most mutual funds also offer the following withdrawal options: withdraw a
specified, fixed dollar amount each investment period, liquidate or sell off a certain
number of shares each investment period, withdraw a fix
ed percent of asset growth each
investment period, or withdraw all income that results from interest, dividends, and
capital gain distributions. (pp. 377
-
379)


INTERNET CONNECTION (p. 382)


After obtaining this data, students should be able to discuss the

type of information that could
help improve their mutual fund investment decisions.


CASE IN POINT

Research Information Available from Morningstar (p. 383)

1.

Based on the research provided by Morningstar, would you buy shares in the T. Rowe Price
Growt
h Stock Fund? Justify your answer.

Each student will have to answer this question based on his or her own investment objectives.
All answers should be based on the information contained in Exhibit 13
-
6 on p. 371.


2.

What other investment information woul
d you need to evaluate this fund? Where would you
obtain this information?

It would be possible to compare the information contained in the Morningstar report with
similar reports published by Standard & Poor’s Corporation, Lipper Analytical Services, and

Value Line. This information would be available in many libraries. You could also use the
Internet to research the T. Rowe Price Growth Stock Fund. You could also call or use the
Internet to contact the investment company that sponsors the fund. Then it

would be possible
to request a prospectus and an annual report. Finally, it would be possible to research the
company through selected business or personal finance periodicals. Again, many libraries
have these publications. (pp. 368
-
374)


3.

On June 2
, 2004, shares in the T. Rowe Price Growth Stock Fund were selling for $24.58 per
share. Using the Internet or a current newspaper, determine the current price for a share of
this fund. Based on this information, would your investment have been profitable
? (Hint:
The symbol for this fund is PRGFX)

This answer will depend on if the current price obtained by students is higher or lower than
the price on June 2, 2004.


4.

Assuming you purchased shares in the T. Rowe Price Growth Stock Fund on June 2, 2004,
an
d based on your answer to Question 3, how would you decide if you want to hold or sell
your shares? Explain your answer.

The answer for this question depends on two factors. First, has the fund increased or
decreased in value. Second, and more importantly,

the fund must be evaluated at the present
time. Investors cannot rely on research that is outdated. An investment should always be
evaluated using the most current information that is available.