Fundamentals of Financial Instruments, 2nd Edition

CHAPTER 11Mutual Funds, ETFs, and Pension Funds

INTRODUCTION

What is a mutual fund? A mutual fund can be defined as a collection of stocks, bonds, or other securities such as precious metals and real estate that is purchased by a pool of individual investors and managed by a professional investment company.

When investors make an investment in a mutual fund, their money is pooled with that of other investors who have chosen to invest in the fund. The pooled sum is used to build an investment portfolio if the fund is just commencing its operations, or to expand its portfolio if it is already in business. All investors receive shares of the fund in proportion to the amount of money they have invested. Every share that an investor owns represents a proportional interest in the portfolio of securities managed by the fund.

When a fund is offering shares for the first time, known as an IPO, the shares will be issued at par. Subsequent issues of shares will be made at a price that is based on what is known as the Net Asset Value (NAV) of the fund. The Net Asset Value of a fund at any point in time is equal to the total value of all securities in its portfolio less any outstanding liabilities, divided by the total number of shares issued by the firm.

The NAV will fluctuate from day to day as the value of the securities held by the fund changes. On a given day, from the perspective of shareholders, the NAV may be higher or lower than the price that they paid per share at the time of ...