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The Handbook of Financial Instruments by Frank J. Fabozzi

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Chapter 21 Investment Companies

Frank J. Jones, Ph.D.

Chief Investment Officer The Guardian Life Insurance Company of America

Frank J. Fabozzi, Ph.D., CFA

Adjunct Professor of Finance School of Management Yale University

Investment companies are entities that sell shares to the public and invest the proceeds in a diversified portfolio of securities. Each share sold represents a proportional interest in the portfolio of securities managed by the investment company on behalf of its shareholders. The type of securities purchased depends on the company’s investment objective.

TYPES OF INVESTMENT COMPANIES

There are three types of investment companies: open-end funds, closed-end funds, and unit trusts.

Open-End Funds (Mutual Funds)

Open-end funds, commonly referred to simply as mutual funds, are portfolios of securities, mainly stocks, bonds, and money market instruments. There are several important aspects of mutual funds. First, investors in mutual funds own a pro rata share of the overall portfolio. Second, the investment manager of the mutual fund actively manages the portfolio, that is, buys some securities and sells others (this characteristic is unlike unit investment trusts, discussed later).

Third, the value or price of each share of the portfolio, called the net asset value (NAV), equals the market value of the portfolio minus the liabilities of the mutual fund divided by the number of shares owned by the mutual fund investors. That is,

For example, suppose that a mutual ...

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