Deck 13: Investing in Mutual Funds, Exchange-Traded Funds, and Real Estate

Question 1

Christine Jacobs is considering whether she should invest some extra money in a mutual fund or an exchange traded fund. Explain the key factors that should influence her decision.

Answer 1

ETF (Exchange Traded Fund) and Mutual fund are the pool of investment, but they differ in the respect of investment strategy. A Mutual Fund can select any security to earn high return from the investment but ETF invests only in index of exchanges. The ETF track and invests only in index, so its operating expenses are lower as compared to Mutual Fund.
Some of the factors which influence investment decision of an investor between ETF and Mutual Fund are given below.
• Diversification: ETF have a narrow market segment and focuses on a specific industry as compared to mutual funds. The level of diversification may be considered in choosing between the two options.
• Tax Management: ETF has a better tax management tool and help in reducing the capital gain taxes as against mutual funds.
• Operating Cost: Operating expenses of the mutual fund is higher because of their loads and tracking of individual security. But the ETF has very lower costs compared to mutual fund, because ETF has no load and low operating expenses.
• Trading time: Mutual funds will be traded at the end of the day only whereas ETF can be traded throughout the day. Also investor can get the price of the ETF on demand.
• Return: The return on the investment can be increased when the investment made in ETF compared to mutual fund, because they incur lower operating expense.
The above mentioned factors severely influence investor decision between ETF and Mutual Fund. Suppose, if an investor is looking for diversified investment then she would choose Mutual Fund over ETF.

Question 2

For each pair of funds listed below, select the fund that would be the least risky and briefly explain your answer.
a. Growth versus growth-and-income
b. Equity-income versus high-grade corporate bonds
c. Intermediate-term bonds versus high-yield municipals
d. International versus balanced

Answer 2

Growth and Income funds are safer when compared to that of growth funds. These funds will invest in high quality of equity. Thus, income and capital gains will be earned. While growth funds invest in stocks with above average growth with above average risk levels.
Thus,
are least risky funds.
Equity income will invest in quality equity. And high grade corporate bonds will invest in junk bonds with high risk.
Thus, less risky funds are
.
High yield municipals invest in tax exempted securities issued by government bodies and hence more secure. Intermediate-term bonds are not like high yield municipals.
Therefore,
are least risky fund.
A balanced fund is safer as is invests in high quality stocks and bonds. Thus, it ensured a stable return along with a capital appreciation. But International funds are risker due to various global factors.
Therefore, less risky fund is
.

Question 3

About a year ago, John Bates bought some shares in the Seismic Mutual Fund. He bought the stock at $24.50 a share, and it now trades at $26.00. Last year, the fund paid dividends of 40 cents a share and had capital gains distributions of $1.83 a share. Using the approximate yield formula, what rate of return did John earn on his investment? Repeat the calculation using a handheld financial calculator. Would he have made a 20% rate of return if the stock had risen to $30 a share?

Answer 3

Approximate yield is the rate of return an investor received on his investment for a period. The following given information would be used to compute the approximate yield.
Stock price at the time of purchase = $24.50 per share
Current price = $26.00 per share.
Dividend received = $0.40 per share
Capital gains = $1.83 per share
Time = 1 year
The approximate yield can be computed by using the formula given below.
…… (1)
Substitute, $2.23
for income, $26.00 for ending price, and $24.50 for beginning price in equation (1) ,
Therefore, rate of return on the investment is 14.77%.
Now, compute the yield by using the "Rate" function of spreadsheet. Enter values and formulas in spreadsheet as shown in the image below.
Obtained result is shown below.
Thus, the yield is 15.22%.
Compute approximate yield if the stock price increases to $30.
Substitute, $2.23
for income, $30.00 for ending price, and $24.50 for beginning price in equation (1) ,
Therefore, rate of return on the investment in this case is 28.37% and it is more than 20%.

Question 4

Describe an ETF and explain how these funds combine the characteristics of open- and closed-end funds. In the Vanguard family of funds, which would most closely resemble a "Spider" (SPDR)? In what respects are the Vanguard fund (that you selected) and SPDRs the same and how are they different? If you could invest in only one of them, which would it be? Explain.

Question 5

A year ago, the Green Technologies Growth Fund was being quoted at an NAV of $21.50 and an offer price of $23.35; today, it's being quoted at $23.04 (NAV) and $25.04 (offer). Use the approximate yield formula or a handheld financial calculator to find the rate of return on this load fund; it was purchased a year ago, and its dividends and capital gains distributions over the year totaled $1.05 a share. ( Hint: As an investor, you buy fund shares at the offer price and sell at the NAV.)

Question 6

Jamie Thompson is thinking about investing in some residential income-producing property that she can purchase for $200,000. Jamie can either pay cash for the full amount of the property or put up $50,000 of her own money and borrow the remaining $150,000 at 8% interest. The property is expected to generate $30,000 per year after all expenses but before interest and income taxes. Assume that Jamie is in the 28% tax bracket. Calculate her annual profit and return on investment assuming that she (a) pays the full $200,000 from her own funds or (b) borrows $150,000 at 8%. Then discuss the effect, if any, of leverage on her rate of return. ( Hint: Earnings before interest taxes minus Interest expenses (if any) equals Earnings before taxes minus Income taxes (@28%) equals Profit after taxes.)