Solutions for Chapter 17: Questions and Problems
CHAPTER 17
PROFESSIONAL MONEY MANAGEMENT,
ALTERNATIVE ASSETS, AND INDUSTRY ETHICS
Answers to Questions
1.
Private management and advisory firms typically develop a personal relationship with
their clients, getting to know the specific investment objectives and constraints of each.
The collection of assets held can then be tailored to the special needs of the client.
Conversely, a mutual fund (investment company) offers a general solution to an
investment problem and then markets that portfolio to investors who might fit that
profile.
Special attention comes at a cost and for that reason private management firms are used
mainly by investors with substantial levels of capital, such as pension funds and high net
worth individuals. Conversely, individual investors with relatively small pools of capital
are the primary clients of investment companies.
The majority of private management and advisory firms are still much smaller and more
narrowly focused on a particular niche in the market. A wide variety of funds is available,
so an investor can match almost any investment objective or combination of investment
objectives.
Management and advisory firms hold the assets of both individual and institutional
investors in separate accounts, which allows for the possibility of managing each client’s
portfolio in a unique manner. Conversely, investment companies are pools of assets that
are managed collectively. Investors in these funds receive shares representing their
proportional ownership in the underlying portfolio of stocks, bonds, or other securities.
2.
Based on Exhibit 17.2, there has been a rapid increase in the number of large asset
management firms. Much of this asset growth can be explained by the strong
performance of the equity markets during this period, but there has been a trend toward
consolidating assets under management in large, multiproduct firms.
3.
After the initial public sale of units in the investment company the open-end fund will
continue to sell new units to the public at the NAV with or without a sales charge and
will redeem (buy back) fund units at the NAV. In contrast, the closed-end fund does not
buy or sell units once the original issue is sold. Therefore, the purchase price or sales
price for a closed-end fund is determined in the secondary market. If the closed-end fund
units are not liquid they will sell at a discount, possibly creating losses for investors who
purchased units at their IPO.
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Solutions for Chapter 17: Questions and Problems
4.
A load fund charges a fee for the sale of units (front end load) and/or redeeming units
(back end load). It will sell units at its net asset value plus the sales charge. A no-load
fund has no initial sales charge, so it will sell its units at its net asset value.
5.
You definitely should care about how well a mutual fund is diversified. One of the main
advantages of a mutual fund is instant diversification, so it truly is important. Given the
CAPM, it is known that the market only pays for systematic risk so it is important to
eliminate unsystematic risk, which is the purpose of diversification. An undiversified
fund is making unsystematic “bets” that investor may not be aware of (unless they
carefully review the fund’s statements and statistical analyses).
6.
As an investor, it is the net return that is important because these are the returns that you
derive. The net return for a fund is the return after all research and management costs.
The gross return is before these expenses. The net return is the return reported to the
stockholder since all expenses have been allowed for in the NAV. To compute the gross
return it is necessary to compute the expenses of the fund and add these back to the
ending NAV and compute the returns with these expenses added back. Typically, the
average difference in return is about one percent a year, but this varies by fund.
7.
It is questionable whether good performance will continue during two successive shortterm periods because in many cases it could be a random event of a couple of winners
that are not repeated. Empirically, such superior performance has not been consistent
beyond what you would expect by chance.
8.
Managers are often compensated with a base salary and a bonus that depends on the
performance of their portfolios relative to those of their peers. Therefore, a manager with
a relative poor performance midway through a compensation period could be more likely
to increase the risk of the portfolio in an effort to increase his/her final standing. Of
course, altering fund risk to enhance his/her own compensation suggests that some
managers may not always act in his/her client’s best interest.
9.
Soft dollars are generated when a manager commits the investor to paying a brokerage
commission that is higher than the simple cost of executing a stock trade in exchange for
the manager receiving additional bundled services from the broker. One example would
be for a manager to route her trades through a non-discount broker in order to receive
security reports that the brokerage firm produces.
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Solutions for Chapter 17: Questions and Problems
CHAPTER 17
Answers to Problems
1.
2.
$50,000
 6,250
$8.00
Current NAV = $75,800/6,250 units = $12.13
Initial number of units 
Load fund = ($1,000 - $80) × 1.15 = $1,058.00
Represents a 5.80% growth
No-load fund = ($1,000 × 1.12) × (1 - .01) = $1,108.80
Represents a 10.88% growth
The no-load fund offers an extra $50.80 over the load fund for a $1,000 investment held
over a one-year time period. The difference in percent growth is 5.08%.
3.
Period
0
1
2
3
4
NAV
$10.00
11.25
9.85
10.50
12.30
Premium/Discount
0.0
-5.0
+2.3
-3.2
-7.0
Market Price Annual Return
$10.00
10.69
6.9%
10.08
-5.7
10.16
0.8
11.44
12.6
3(a).
Using the above data, the arithmetic average return per year is 3.65%. On an annual
compounded (geometric average) basis, the average annual return is 3.42%.
This latter answer is the same as if the annual return is computed using only the end
points, units were worth $11.44 at the end of year 4 and were purchased for $10,
giving a compounded return of ($11.44 / $10).25 -1 = 3.42%
3(b).
(12.30 / 10.00) (1/4) – 1 = 5.31%
3(c).
3(d).
Ignoring commission, shares were purchased $10.69 and sold at 10.08, a return of 5.7%
Change is NAV is $9.85 - $11.25 = $-1.40; the percentage change is $-1.40 / 11.25
= -12.44%
4(a).
Client 1
.0100 × 5,000,000 = 50,000
.0075 × 5,000,000 = 37,500
.0060 × 10,000,000 = 60,000
.0040 × 7,000,000 = 28,000
27,000,000 175,500
Client 2
.0100 × 5,000,000 = 50,000
.0075 × 5,000,000 = 37,500
.0060 × 10,000,000 = 60,000
.0040 × 77,000,000 = 308,000
97,000,000 455,500
4(b).
175,500/27,000,000 = .0065 or 0.65%
455,000/97,000,000 = .004696 = 0.47%
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Solutions for Chapter 17: Questions and Problems
4(c). Costs of management do not increase at the same rate as the managed assets because
substantial economies of scale exist in managing assets.
5.(a).
Beginning value
= $27.15 × 257.876 = $7,001.33
Capital gain & dividends = $1.12 × 257.876 =
288.82
Ending value
= $30.34 × 257.876 = 7,823.96
($7,823.96 - $7,001.33) + 288.82
Return =
= 15.87%
$7,001.33
which can be computed on a per-unit basis:
[($30.34 – 27.15) + 1.12] / $27.15 = 0.1587 or 15.87%
Only the dividend distribution is taxable; the units are not yet sold so the change in
NAV does not represent a taxable (realized) gain or loss:
[($30.34 - 27.15) + 1.12(1 – 0.24)] / $27.15
= 4.04 / $27.15 = 0.1488 or 14.88%
5(b).
5(c).
The investor received a distribution of $1.12 per unit which, at the year-end NAV,
purchases $1.12/$30.34 = 0.036915 units. Since the investor owned 257.876 units, he can
purchase 9.519 units (if there were no tax). If the distribution were taxable the after-tax
distribution of $1.12 (1-.24) = $0.851 could purchase 0.0281 units—for a total of 7.235
units.
6.
Stock
A
B
C
D
E
F
G
H
I
J
K
L
M
Cash
Total
Expenses
Year 1
Shares (000)
100
225
375
115
154
175
212
275
450
90
87
137
0
price
$45.25
$25.38
$14.50
$87.13
$56.50
$63.00
$32.00
$15.25
$9.63
$71.25
$42.13
$19.88
$17.75
Year 2
MV (000) Shares (000)
$4,525.00
100
$5,710.50
225
$5,437.50
375
$10,019.95
115
$8,701.00
154
$11,025.00
175
$6,784.00
212
$4,193.75
275
$4,333.50
450
$6,412.50
90
$3,665.31
87
$2,723.56
0
$0.00
150
$3,542.00
$77,073.57
$730,000.00
- 135 Copyright © 2010 by Nelson Education Ltd.
price
$48.75
$24.75
$12.38
$98.50
$62.50
$77.00
$38.63
$8.75
$27.45
$75.38
$49.63
$27.88
$19.75
MV (000)
$4,875.00
$5,568.75
$4,642.50
$11,327.50
$9,625.00
$13,475.00
$8,189.56
$2,406.25
$12,352.50
$6,784.20
$4,317.81
$0.00
$2,962.50
$2,873.00
$89,399.57
$830,000.00
Solutions for Chapter 17: Questions and Problems
a.
NAV =
number in 000
Sum of market values + cash divided by 5,430,000 units
$77,073.57 divided by
5,430 =
$14.19
Note: NAV is (market value of assets – liabilities) /# units. Expenses are not included in this calculation
b.
NAV =
number in 000
Percent change:
c.
Sum of market values + cash divided by 5,430,000 units
$89,399.57 divided by
5,430 =
15.99%
$16.46
# units = cash account / year 2 NAV
=
174.502 units
d.
A
B
C
D
E
F
G
H
I
J
K
L
M
Year 2
Shares (000)
100
225
375
115
154
175
212
275
450
90
87
0
150
Total value, shares only
Amount to liquidate:
Less cash:
7(a).
price
$48.75
$24.75
$12.38
$98.50
$62.50
$77.00
$38.63
$8.75
$27.45
$75.38
$49.63
$27.88
$19.75
MV (000)
$4,875.00
$5,568.75
$4,642.50
$11,327.50
$9,625.00
$13,475.00
$8,189.56
$2,406.25
$12,352.50
$6,784.20
$4,317.81
$0.00
$2,962.50
% holding
5.63%
6.44%
5.37%
13.09%
11.12%
15.57%
9.46%
2.78%
14.28%
7.84%
4.99%
0.00%
3.42%
$86,526.57
$16.31 x
8,230,000 minus
Dollars to
be sold
$301,819.14
$344,770.33
$287,424.69
$701,303.86
$595,899.33
$834,259.06
$507,028.92
$148,974.83
$764,763.27
$420,020.80
$267,322.61
$0.00
$183,413.17
Number of
shares sold
6,191.2
13,930.1
23,216.9
7,119.8
9,534.4
10,834.5
13,125.3
17,025.7
27,860.2
5,572.0
5,386.3
0.0
9,286.7
100.0% $5,357,000.00
500,000 =
2,873,000 =
(1) 3% front-end load = $100,000 (1 - .03) = $97,000
$97,000 (1 + .12)3 = $97,000(1.4049) = $136,278
(2) a 0.50% annual deduction (assumed to be deducted at year-end)
Year 1: $100,000(1 + .12) = $112,000 (1 - .005) = $111,440
Year 2: $111,440(1 + .12) = $124,812.80(1 - .005) = $124,188.74
Year 3: $124,188.74(1 + .12) = $139,091.38(1 - .005) = $138,395.93
(3) a 2% back-end load
$100,000(1 + .12)3 = $100,000(1.4049) = $140,492.80
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$8,230,000
$5,357,000
Solutions for Chapter 17: Questions and Problems
$140,492.80(1 - .02) = $137,682.94
Choice (2) with ending wealth of $138,395.93
7(b).
(1) 3% front-end load = $100,000 (1 - .03) = $97,000
$97,000 (1 + .12)10 = $97,000(3.10585) = $301,267.28
(2) a 0.50% annual deduction
$100,000(1 + .12) 10 (1 - .005) 10 = $100,000(3.10585)(.9511)
= $295,400.54
(3) a 2% back-end load
$100,000(1 + .12)10 = $100,000(3.10585) = $310,584.82
$310,584.82(1 - .02) = $304,373.12
Answer would change, now choice (3) with ending wealth of $304,373.12
7(c).
A front-end load takes the money out right away, thus reducing your initial deposit.
The annual fee is usually less than one percent, which is a small amount and based on the
example the preferred choice for a holding period of three years.
A back-end load is usually a smaller percentage than a front-end load, though the dollar
amount has typically grown during the holding period. However, back-end loads are not
due until the fund is liquidated, in this case, a long period of time.
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