Fall 2013 ADVANCED FINANCIAL INSTRUMENTS AND MARKETS

LectureNo.04 PortfolioDiversificationand SupportingFinancialInstitutions

Hammad HassanMirza AssistantProfessor(Finance) DepartmentofBusinessAdministration UniversityofSargodha

Todays Today sDiscussion

PortfolioDiversification InstitutionofMutualFund
OpenEnded CloseEnded

AssetPricingModels
Sharpe FamaandFrench

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PortfolioandDiversification

APortfolioofaRiskyandRisklessAsset UnitedEastIndiaCompany1602(EvolutionofShare) AmsterdamStockExchange g TheEquityPremiumPuzzle HarryMarkowitzandtheOriginsofPortfolioAnalysis EfficientPortfolioFrontiers

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APortfolioofaRiskyand RisklessAsset

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APortfolioofTwoRiskyAssets

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EfficientPortfolioFrontierwith TwoAssets

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PortfolioVariance,ThreeRisky Assets

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SharpRatio

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Beta

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S i II Session

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TypesofInvestmentCompanies

Open O End dFunds d ClosedEndFunds UnitTrusts

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MutualFundExpenses

TypesofCosts
Shareholderfeeorsales charge Operatingexpenseor expenseratio

TypesofLoads
Frontendload Backendload Levelload

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EconomicFunctionsof Funds
RiskReductionviaDiversification LowerCostsofContractingandInformation Processing ProfessionalPortfolioManagement Liquidity Variety PaymentsMechanism
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FundInvestmentObjectives
EquityFunds
Income AggressiveGrowth Growth IncomeandGrowth

BondFunds
U.S.GovernmentBonds CorporateBonds ConvertibleSecurities Municipal p Bonds

MoneyMarketMutual Funds
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Others

FamilyofFunds
Group ofdifferentfundswithavarietyofinvestment objectivesmanaged byaninvestmentadvisory company. EconomicBenefits:
Flexibility Lowercosts Wider Choices

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TaxationofMutualFunds
Distributionsofincomearetaxableattheinvestor level,notthefundlevel.
Ordinaryincometax Capitalgainstax

Capitalgainsdistributions
Longtermcapitalgains Shorttermcapitalgains

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FederalRegulationofFunds

SecuritiesActs of1933and1934 InvestmentCompanyActof1940 InvestmentAdvisorsActof1940 94 InsiderTradingandSecuritiesFraudEnforcementAct of1988

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RecentSECPrioritiesConcerning MutualFunds
Reportingfundreturnsonaftertaxbasis Morecompletereportingoffeescharged Moreaccurateandconsistentreportingof investmentperformance Greater consistencybetweenfundpracticesand investmentobjective Disclosureof portfoliopractices Requiring i i fund f dmanagerstolist li their h i security i holdingsmorefrequently Rulestoincreaseeffectivenessandindependence ofboardsofdirectors
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StructureofFunds

BoardofDirectors MutualFund Distributor OtherServiceProviders

External(independentpublicaccountant,custodian, transfer f agent) ) Internal(marketing,legal,reporting,etc.)

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RecentChangesintheMutual FundIndustry
DistributionChannels
Supermarkets Wrap pPrograms g FeeBasedFinancialAdvisors VariableAnnuities

PurchaseCost ofMutualFunds MixandMatch Mergers M and dAcquisitions A i iti in i the th U.S. U S Fund F dMarket M k t InternationalizationofBusinessbyU.S.Funds
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AlternativestoMutualFunds
Exchangetraded funds, or ETFs, are investment companies that are legally classified as openend companies or Unit Investment Trusts (UITs), but that differ from traditional openend companies and UITs in the following respects: ETFs do not sell individual shares directly to investors and only issue their shares in large blocks (blocks of 50,000 shares, for example) that are known as "Creation Units.
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ExchangeTradedFunds
InvestorsgenerallydonotpurchaseCreationUnits withcash.Instead, ,they ybuy yCreationUnitswitha basketofsecuritiesthatgenerallymirrorstheETFs portfolio.ThosewhopurchaseCreationUnitsare frequentlyinstitutions institutions. AfterpurchasingaCreationUnit,aninvestoroften splitsitupandsellstheindividualsharesona secondarymarket.Thispermitsotherinvestorsto purchaseindividualshares(insteadofCreationUnits).
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ExchangeTradedFunds
Investors who h want to sell ll their h i ETF shares h h have two options: (1) they can sell individual shares to other investors on the secondary y market, , or ( (2) ) they y can sell the Creation Units back to the ETF. In addition, ETFs generally redeem Creation Units by giving investors the securities that comprise the portfolio instead of cash. So, for example, an ETF invested in the stocks contained in the Dow Jones Industrial Average (DJIA) would ld give i a redeeming d i shareholder h h ld the h actual l securities that constitute the DJIA instead of cash. y of ETF shares, Because of the limited redeemability ETFs are not considered to beand may not call PropertyofDepartmentofBusinessAdministration,Universityof 23 themselvesmutual funds. Sargodha

CommercialBanksandMutual Funds
DualRelationshipwithMutualFunds
DistributingFunds ManagingFunds

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EconomicFunctions

MaturityIntermediation RiskReduction LowerCosts PaymentsMechanism

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ThankYou!
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