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Management of Financial Institutions

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Management of Financial Institutions - MGT 604
VU
Lecture # 24
Mutual Funds
Balanced Funds
The basic objectives of balanced funds are to generate income as well as long-term growth
of principal. These funds generally have portfolios consisting of bonds, preferred stocks,
and common stocks. They have fairly limited price rise potential, but do have a high degree
of safety, and moderate to high income potential.
Investors who desire a fund with a combination of securities in a single portfolio, and who
seek some current income and moderate growth with low-level risk, would do well to invest
in balanced mutual funds. Balanced funds, by and large, do not differ greatly from the
growth and income funds described above.
Growth Funds
Growth funds are offered by every investment company. The primary objective of such
funds is to seek long-term appreciation (growth of capital). The secondary objective is to
make one's capital investment grow faster than the rate of inflation. Dividend income is
considered an incidental objective of growth funds.
Growth funds are best suited for investors interested primarily in seeing their principal grow
and are therefore to be considered as long-term investments - held for at least three to five
years. Jumping in and out of growth funds tends to defeat their purpose. However, if the
fund has not shown substantial growth over a three - to five-year period, sell it (redeem your
shares) and seek a growth fund with another investment company. Candidates likely to
participate in growth funds are those willing to accept moderate to high risk in order to
attain growth of their capital and those investors who characterize their investment
temperament as "fairly aggressive.
Index Funds
The intent of an index fund is basically to track the performance of the stock market. If the
overall market advances, a good index fund follows the rise. When the market declines, so
will the index fund. Index funds' portfolios consist of securities listed on the popular stock
market indices.
It is also the intent of an index fund to materially reduce expenses by eliminating the fund
portfolio manager. Instead, the fund merely purchases a group of stocks that make up the
particular index it deems the best to follow. The stocks in an index fund portfolio rarely
change and are weighted the same way as its particular market index. Thus, there is no need
for a portfolio manager. The securities in an index mutual fund are identical to those listed
by the index it tracks, thus, there is little or no need for any great turnover of the portfolio of
securities. The funds are "passively managed" in a fairly static portfolio. An index fund is
always fully invested in the securities of the index it tracks.
An index mutual fund may never outperform the market but it should not lag far behind it
either. The reduction of administrative cost in the management of an index fund also adds to
its profitability
Sector Funds
As was discussed earlier, most mutual funds have fairly broad-based, diversified portfolios.
In the case of sector funds, however, the portfolios consist of investment from only one
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Management of Financial Institutions - MGT 604
VU
sector of the economy. Sector funds concentrate in one specific market segment; for
example, energy, transportation, precious metals, health sciences, utilities, leisure industries,
etc. In other words, they are very narrowly based.
Investors in sector funds must be prepared to accept the rather high level of risk inherent in
funds that are not particularly diversified. Any measure of diversification that may exist in
sector funds is attained through a variety of securities, albeit in the same market sector.
Substantial profits are attainable by investors astute enough to identify which market sector
is ripe for growth - not always an easy task.
Specialized Funds
Specialized funds resemble sector funds in most respects. The major difference is the type
of securities that make up the fund's portfolio. For example, the portfolio may consist of
common stocks only, foreign securities only, bonds only, new stock issues only, over - the -
counter securities only, and so on.
Those who are still novices in the investment arena should avoid both specialized and sector
funds or the time being and concentrate on the more traditional, diversified mutual funds
instead
Islamic Funds
In case of Islamic Funds, the investment made in different instruments is to be in line with
the Islamic Shairah Rules. The Fund is generally to be governed by an Islamic Shariah
Board. And then there is a purification process that needs to be followed, as some of the
money lying in reserve may gain interest, which is not desirable in case of Islamic
investments.
Risks in Mutual Fund Investing
There is some degree of risk in every investment. Although it is reduced considerably in
mutual fund investing. Do not let the specter of risk stop you from becoming a mutual fund
investor. However, it behaves all investors to determine for them the degree of risk they are
willing to accept in order to meet their objectives before making a purchase. Knowing of
potential risks in advance will help you avoid situations in which you would not be
comfortable. Understanding the risk levels of the various types of mutual funds at the outset
will help you avoid the stress that might result from a thoughtless or a hasty purchase.
Let us now examine the risk levels of the various types of mutual funds.
Low Level Risks
·
Moderate level Risks
·
High Level Risks
·
Measuring Risks
LOW-LEVEL RISKS
Mutual funds characterized as low-level risks fall into here categories
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Management of Financial Institutions - MGT 604
VU
1. Money market funds
2. Treasury bill funds
3. Insured bond funds
MODERATE-LEVEL RISKS
Mutual funds considered moderate-risk investments may be found in at least the eight types
categorized below.
1. Income funds
2. Balanced funds
3. Growth and income funds
4. Growth funds
5. Short-term bond funds (taxable and tax-free)
6. Intermediate bond funds (taxable and tax-free)
7. Insured government/municipal bond funds
8. Index funds.
HIGH-LEVEL RISKS
The types of funds listed below have the potential for high gain, but all have high risk levels
as well.
1. Aggressive growth funds
2. International funds
3. Sector funds
4. Specialized funds
5. Precious metals funds
6. high-yield bond funds (taxable and tax-free)
7. Commodity funds
8. Option funds
MEASURING RISK
As you become a more experienced investor, you may want to examine other, more
technical, measures to determine risk factors in your choice of funds.
Beta coefficient is a measure of the fund's risk relative to the overall market. For example,
a fund with a beta coefficient of 2.0 means that it is likely to move twice as fast as the
general market ­ both up and down. High beta coefficients and high risk go hand in hand.
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Management of Financial Institutions - MGT 604
VU
Alpha coefficient is a comparison of a fund's risk (beta) to its performance. A positive
alpha is good. For example, an alpha of 10.5 means that the fund manager earned an
average of 10.5% more each year than might be expected, given the fund's beta.
Interest rates and inflation rates are other factors that can be used to measure investment
risks. For instance, when interest rates are going up, bond funds will usually be declining,
and vice versa. The rate of inflation has a decided effect on funds that are sensitive to
inflation factors; for example, funds that have large holdings in automaker stocks, real estate
securities, and the like will be adversely affected by inflationary cycles.
R-Square factor is a measure of the fund's risk as related to its degree of diversification.
The information is supplied here merely to acquaint you with the terminology in the event
you should wish to delve more deeply into complex risk factors. The more common risk
factors previously described are all you really need to know for now, and perhaps for years
to come.
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Table of Contents:
  1. Financial Environment & Role of Financial Institutions:FINANCIAL MARKETS &INSTITUTIONS
  2. FINANCIAL INSTITUTIONS:Non Banking Financial Companies
  3. CENTRAL BANK:Activities and responsibilities, Interest Rate Interventions
  4. POLICY INSTRUMENTS:Open Market Operations, Capital Requirements
  5. BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability
  6. STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments
  7. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS:Banking Inspection Department
  8. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Debt Management
  9. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Training Programs by SBP
  10. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Human Resources Department
  11. MAJOR DRIVERS OF FINANCIAL INDUSTRY:GLOBAL FINANCIAL SYSTEM, The World Bank
  12. INTERNATIONAL FINANCIAL INSTITUTIONS:ADB Projects in Pakistan, Paris Club
  13. PAKISTAN ECONOMIC AID & DEBT:Macroeconomic Stability, Strengthening Institutions
  14. INCREASING FOREIGN DIRECT INVESTMENT:Industrial Sector, Managing the Debt
  15. ROLE OF COMMERCIAL BANKS:Services Typically Offered by Banks, Types of banks
  16. ROLE OF COMMERCIAL BANKS:Types of investment banks, The Management of the Banks
  17. ROLE OF COMMERCIAL BANKS:Public perceptions of banks, Capital adequacy, Liquidity
  18. ROLE OF COMMERCIAL BANKS:Problem bank management, BANKING SECTOR REFORMS
  19. ROLE OF COMMERCIAL BANKING:Private Deposit Insurance,
  20. BRANCH BANKING IN PAKISTAN:Remittances, Online Fund Transfer
  21. ROLE OF COMMERCIAL BANKS IN MICRO FINANCE SECTOR
  22. Mutual funds:Types of international mutual funds, Mutual funds vs. other investments
  23. Mutual Funds:Criticism of managed mutual funds, Money Market Fund
  24. Mutual Funds:Balanced Funds, Growth Funds, Specialized Funds, Measuring Risks
  25. Mutual Funds:Cost of Ownership, Redemption Fee, Reports to Shareholders
  26. Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud
  27. Mutual Funds:Investing In International Mutual Funds, How to Pre-Select a Mutual Fund
  28. Role of Investment Banks:Recent evolution of the business, Possible conflicts of interest
  29. Letter of Credit:Elements of a Letter of Credit, Commercial Invoice, Tips for Exporters
  30. Letter of Credit and International Trade:Terminology, Risks in International Trade
  31. Foreign Exchange & Financial Institutions:Investment management firms, Exchange Traded Fund
  32. Foreign Exchange:Factors affecting currency trading, Economic conditions include
  33. Leasing Companies:Basic Purpose of Leasing, Technological Benefits
  34. The Leasing Sector in Pakistan and its Role in Capital Investment
  35. Role of Insurance Companies:Indemnification, Insurer’s business model
  36. Role of Insurance Companies:Life insurance and saving
  37. Role of financial Institutions in Agriculture Sector:What is “Revolving Credit Scheme”?
  38. Agriculture Sector and Financial Institutions of Pakistan:What is SMEs
  39. Can Government of Pakistan Lay a Pivotal Role in this Sector?:Business Environment
  40. Financial Crimes:Process of Money Laundering, Terrorist Financing
  41. DFIs & Risk Management:Managing Credit Risk, Managing Operational Risk
  42. Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits
  43. The Collapse of ENRON:Auditing Issues, Corporate Governance Issues, Corrective Actions
  44. Classic Financial Scandals:Corruption, Discovery, Black Wednesday
  45. RECAP:FINANCIAL INSTITUTIONS, CENTRAL BANK,