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

Question 1

Kate Wittman is considering whether she should invest some extra money in a mutual fund or an ETF. Explain the key factors that should influence her decision.

Answer 1

Person K is planning to invest her extra money. For this purpose she is evaluating two alternatives. One is mutual fund and another one is ETF (exchanged traded fund).
She takes the decision by considering some key factors which affects the decision of K.
Mutual fund has the pool of the different shares and bonds. The selection of the shares and bonds will be conducted by management team of the mutual fund.
ETF also pool of different investments. Thus, this cannot be considered for the purpose of the selection.
Selection between mutual fund and ETF can be made based on the following three criteria:
• Investment diversification: ETF have a narrow market segment and focuses on a specific industry as compared to mutual funds which are more diversified. 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.
• Cost: Expenses of the mutual fund is very higher because of their loads and operating expenses. But the ETF has very lower costs when compared with that of mutual fund. The reason to this is ETF has no load and low operating expenses.
• Trading time: Mutual funds will be traded at end of the day only but ETF cannot be traded like this. There is no limit for ETF. It can be traded at any time during the day. And the investor can get the price of the ETF on his/her demand.
• Return on the investment can be increased when the investment made in ETF when compared that of mutual fund.
• Because of the structure of the ETF, it allows the investor to pay less tax when compared to that of mutual funds.
Based on the above factors, K can take the decision.

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, Nigel Palmer bought some shares in the Equity Partners 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 Nigel earn on his investment? Repeat the calculation using a handheld financial calculator. Would he have made a 20 percent rate of return if the stock had risen to $30 a share?

Answer 3

Investor N purchased the stock at $24.50 per share one year ago. The current price of the share is $26.00. And N received the dividend of $0.40 and capital gains of $1.83 per share.
Calculate the rate of return using the formula of approximate yield:
Substitute $2.23
for income, $26.00 for ending price, and $24.50 for beginning price in the formula:
Therefore, rate of return on the investment of N is
.
The results using a handheld financial calculator would return a figure of 15.22% which closest to the approximate yield calculated above.
Calculate the rate of return to know whether N earns 20% return if the current price is $30:
Substitute $2.23
for income, $30.00 for ending price, and $24.50 for beginning price in the formula:
Therefore, rate of return on the investment of N in this case is
.
Therefore, N earns more than 20% rate of return if the current price is $30.

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

Do an online search and see what information you can find on the PowerShares QQQ ETF. Discuss what information you need to evaluate the performance of the ETF, and use what you find to evaluate the QQQ ETF. What kind of investor should invest in this ETF?

Question 6

A year ago, the Alpine 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 7

Lilia Castillo is thinking about investing in some residential income-producing property that she can purchase for $200,000. Lilia 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 percent interest. The property is expected to generate $30,000 per year after all expenses but before interest and income taxes. Assume that Lilia is in the 28 percent 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 percent. 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 percent) equals Profit After Taxes.)