1
Chapter Twenty
Understanding Personal Finances and Investments
Learning Objectives
1. Explain why you should manage your personal finances and develop a personal investment program.
2. Describe how the factors of safety, risk, income, growth, and liquidity affect your investment decisions.
3. Understand how securities are bought and sold.4. Identify the advantages and disadvantages of savings
accounts, bonds, stocks, mutual funds, and real estate.5. Describe high‐risk investment techniques.6. Use financial information to evaluate investment
alternatives.
Copyright © Cengage Learning. All rights reserved. 20 | 2
2
Chapter 20 Outline
– Preparing for an Investment Program• Managing Your Personal FinancesManaging Your Personal Finances• Investment Goals• A Personal Investment Program• Important Factors in Personal Investment
– How Securities Are Bought and Sold• The Primary Market• The Secondary Market• The Role of an Account Executive• Regulation of Securities Trading
Copyright © Cengage Learning. All rights reserved. 20 | 3
Chapter 20 Outline (cont’d)
– Traditional Investment AlternativesP tf li M t• Portfolio Management
• Asset Allocation, the Time Factor, and Your Age
• Bank Accounts
• Corporate and Government Bonds
• Common Stock
• Preferred StockPreferred Stock
• Mutual Funds
• Real Estate
Copyright © Cengage Learning. All rights reserved. 20 | 4
3
Chapter 20 Outline (cont’d)
– High‐Risk Investment TechniquesS lli Sh t• Selling Short
• Buying Stock on Margin
• Other High‐Risk Investments
– Sources of Financial Information• The Internet
• Financial Coverage of Securities Transactions• Financial Coverage of Securities Transactions
• Other Sources of Financial Information
• Security Averages
Copyright © Cengage Learning. All rights reserved. 20 | 5
Preparing for an Investment Program• Managing Your Personal Finances
– The use of your personal funds to earn a financial treturn
– Personal budget is a specific plan for spending income
• Investment goals– Personal investment goals must be
S ifi d bl• Specific and measurable• Tailored to individual needs• Focused on the future• Realistic in terms of economic conditions and
opportunitiesCopyright © Cengage Learning. All rights
reserved. 20 | 6
4
Preparing for an Investment Program (cont’d)
• Questions to consider when establishing goals– What financial goals do you want to achieve?
– How much money will you need and when?– How much money will you need, and when?
– What will you use the money for?
– Is it reasonable to assume that you can obtain the amount of money you will need to meet your investment goals?
– Do you expect your personal situation to change in a way that will affect your investment goals?
– What economic conditions could alter your investment goals?– What economic conditions could alter your investment goals?
– Are you willing to make the necessary sacrifices to ensure that your investment goals are met?
– What are the consequences of not obtaining your investment goals?
Copyright © Cengage Learning. All rights reserved. 20 | 7
Preparing for an Investment Program (cont’d)
• A personal investment program– Involves a careful evaluation of different
investment opportunities
– Financial planner
– Begin by accumulating an emergency fund
– Invest funds according to your plang y p
– Monitor the plan
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5
Preparing for an Investment Program (cont’d)
• Suggestions to help you accumulate the money needed to fund an investment plan– Learn to balance your budget
– Make savings a higher priority
– Take advantage of employer‐sponsored retirement programs
– Participate in an elective savings programp g p g
– Make a special savings effort one or two months each year
– Take advantage of gifts, inheritances, and windfalls
Copyright © Cengage Learning. All rights reserved. 20 | 9Source: Jack R. Kapoor, Les R. Dlabay, and Robert J. Hughes, Personal Finance, 9th ed. Copyright © 2009 by The McGraw Hill Companies, Inc.
.
Important Factors in Personal Investment
• Match potential investments with your goals in terms of several factors
– Safety and risk
– Investment income
– Investment growth
– Investment liquidity
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6
Surviving a Financial Crisis
• To survive a financial crisis, many experts recommend that you take action before the crisis to make sure your financial affairs are in order
• Seven steps you can take– Establish a larger than usual emergency fund– Know what you owe– Reduce spending– Pay off credit cards– Apply for a line of credit at your bank credit union or financial– Apply for a line of credit at your bank, credit union, or financial
institution– Notify credit card companies and lenders if you are unable to make
payments– Monitor the value of your investment accounts
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How Securities Are Bought and Sold• Securities are usually exchanged with the help of an
account executive or stockbroker• The primary marketThe primary market
– A market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities
• Investment banking firm
• High‐risk investment
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7
How Securities Are Bought and Sold (cont’d)
• The secondary market– A market for existing financial securities that are
traded between investors
– Securities exchange
– Over‐the‐counter (OTC) market( )
• Nasdaq
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How Securities Are Bought and Sold (cont’d)
• The role of an account executive– An individual, sometimes called a stockbroker orAn individual, sometimes called a stockbroker or
registered representative, who buys and sells securities for clients
• Full‐service broker
• Discount broker
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8
How Securities Are Bought and Sold (cont’d)
• The mechanics of a transaction
– Market order
– Limit order
– Discretionary order
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How Securities Are Bought and Sold (cont’d)
• Online security transactions– Software can help investors evaluate potential
investments, manage investments, monitor value, and place buy and sell orders online
– Investors must still analyze the information and make decisions
– Online trading generally has lower costsProgram trading a computer driven program that– Program trading—a computer‐driven program that monitors the market value of particular stocks and enters buy or sell orders when those stocks reach specified prices
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9
How Securities Are Bought and Sold (cont’d)
• Commissionsb k f h– Most brokerage firms have a minimum commission
– Additional commission charges are based on the number of shares and the value of stock bought and sold
– Generally, online transactions are less expensive when compared to trading through a full‐service brokerage firm
– Full‐service brokerages charge a percentage of the g g p gtransaction amount (as much as 1.5 to 2.0%)
– Commissions for bonds, commodities, and options are lower than for stocks
Copyright © Cengage Learning. All rights reserved. 20 | 17
Regulation of Securities Trading
• A regulatory pyramid of four different levels i t t k i t t t dexists to make sure investors are protected
– 1st level: Federal regulation by the U.S. Congress
– 2nd level: Securities and Exchange Commission (SEC)
– 3rd level: State regulation
– 4th level: Self‐regulation by securities exchanges and brokerage firms
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10
Traditional Investment Alternatives• Portfolio management• Asset allocation, the time factor, and your age
– Asset allocation
– The time factor
– Age
Copyright © Cengage Learning. All rights reserved. 20 | 19
Traditional Investment Alternatives (cont’d)
• Bank accounts– Advantagesg
– Disadvantage
• Corporate bonds
• Convertible bondsCopyright © Cengage Learning. All rights
reserved. 20 | 20
11
Traditional Investment Alternatives (cont’d)
• Government bonds– Considered risk free; pay low interestConsidered risk free; pay low interest– Treasury bills
– Treasury notes
– Treasury bonds
– Savings bonds
– Municipal bonds
Copyright © Cengage Learning. All rights reserved. 20 | 21
Traditional Investment Alternatives (cont’d)
• Common stock– Dividend income
• Stock dividendStock dividend
• Dividend payments
– Increase in dollar value• Capital gain
• Market value
– Stock splits
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12
Traditional Investment Alternatives (cont’d)
• Preferred stock– Stock in a corporation that has a claim on the p
dividends that supersedes common stock
– Cumulative preferred stock
Convertible preferred stock– Convertible preferred stock
Copyright © Cengage Learning. All rights reserved. 20 | 23
Traditional Investment Alternatives (cont’d)
• Mutual funds– A professionally managed investment vehicle that combines and
invests the funds of many individual investors
– Closed‐end funds
– Open‐end funds
– Net asset value (NAV)
Net asset value Value of the fund’s portfolio – Liabilities
Copyright © Cengage Learning. All rights reserved. 20 | 24
Net asset value Value of the fund s portfolio LiabilitiesNumber of shares outstanding
=
• Current market value of a mutual fund’s portfolio minus the mutual fund’s liabilities and divided by the number of outstanding shares
13
Traditional Investment Alternatives (cont’d)
• Mutual funds (cont.)– Load funds
– No‐load funds
– Yearly management fee
– Managed funds
– Index funds
– Family of funds
Copyright © Cengage Learning. All rights reserved. 20 | 25
Traditional Investment Alternatives (cont’d)
• Types of mutual fund investments– Aggressive growth stock funds– Global stock funds– Growth stock funds– High‐yield (junk) bond funds– Income stock funds– Index funds– Long‐term U.S. bond funds– Sector stock funds– Small‐cap stock funds
Copyright © Cengage Learning. All rights reserved. 20 | 26
14
Traditional Investment Alternatives (cont’d)
• Real estate– AdvantagesAdvantages
– Disadvantages
Copyright © Cengage Learning. All rights reserved. 20 | 27
High‐Risk Investment Techniques
• Buying longBuying stocks expected to increase in value which can then can– Buying stocks expected to increase in value, which can then can be sold at a profit
• Selling short– The process of selling stock that an investor does not actually
own but has borrowed from a brokerage firm and will repay at a later date
• Buying stock on margin• Buying stock on margin– Buying stock by borrowing part of the purchase price, usually
from a stock brokerage firm• Margin requirement
Copyright © Cengage Learning. All rights reserved. 20 | 28
15
High‐Risk Investment Techniques (cont’d)
• Other high‐risk i t tinvestments– Stock options
– Commodities
– Precious metals
– GemstonesGemstones
– Coins
– Antiques and collectibles
Copyright © Cengage Learning. All rights reserved. 20 | 29
Sources of Financial Information
• The Internet– www bloomberg comwww.bloomberg.com
– http://money.cnn.com
– www.fool.com
– www.quicken.com
– www.sec.gov
– http://finance.yahoo.com
• Newspaper coverage of securities transactions– Common and preferred stocks
– Bonds
– Mutual funds
Copyright © Cengage Learning. All rights reserved. 20 | 30
16
Sources of Financial Information• Other sources of financial information
– Investors’ services• Moody’s, Standard & Poor’s, Mergent, Value Line, Morningstar, Lipper y , , g , , g , pp
Analytical Services, Wiesenberger Investment Companies
– Brokerage firm analysts’ reports• UBS PaineWebber, Smith Barney, Merrill Lynch
– Business periodicals• Business Week, Fortune, Forbes• Advertising Age, Business Insurance• U.S. News & World Report, Time, Newsweek• Money, Kiplinger’s Personal Finance Magazine, Consumer Reports
– Corporate reports
• A security average (security index) is an average of the current market prices of selected securities
Copyright © Cengage Learning. All rights reserved. 20 | 31
Sources of Financial Information (cont’d)
• Security averages– An average of the current market prices of
selected securities
– Dow Jones Industrial Average
– Standard & Poor’s 500 Stock Index
– New York Stock Exchange Composite Indexg p
– American Stock Exchange Index
– Nasdaq Composite Index
Copyright © Cengage Learning. All rights reserved. 20 | 32
278
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.1 Steps in a Typical Stock Transaction on the New York
Stock ExchangeS
tep
s in
a T
yp
ical S
toc
k T
ran
sactio
n
on
the N
ew
Yo
rk S
tock
Exch
an
ge
Account executive receives your order tosell stock and relays order electronically tobrokerage firm
’s representative on floor of NYS
E.1
Firm’s clerk signals transaction from
booth to broker on stock-exchange floor.
2
Broker goes to trading post w
here stock istraded w
ith a stock-exchange mem
ber who
has an order to buy.3
After the trade is executed, a notice is sentto the brokerage firm
and the consolidatedticker tape.
4
Sale appears on the ticker tape, and
confirmation is relayed to account executive,
who notifies you of com
pleted transaction.5
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© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.2 Typical Commission Costs Charged by Online Brokerage
Firms for a Transaction in Which 1,000 Shares Are Bought or Sold
Source: TD Ameritrade website, www.tdameritrade.com, accessed October 23, 2008.
Typ
ical C
om
mis
sio
n C
osts
Ch
arg
ed
by O
nlin
e B
rokera
ge F
irms fo
r a
Tra
nsactio
n in
wh
ich
1,0
00 S
hare
s
Are
Bo
ug
ht o
r So
ld
Inte
rnet
Inte
ractiv
eV
oic
e-R
esponse
Tele
phone S
yste
mB
roker-A
ssis
ted
TD Am
eritrade$ 9.9
9$
34
.99
$ 4
4.9
9
E*Trade
$12.9
9$
12
.99
$ 5
7.9
9
Fidelity$19.9
5$
67
.50
$18
1.0
0
Schw
ab$12.9
5$
17
.95
$ 3
7.9
5
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280
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.3 Investment Alternatives
Investm
en
t Alte
rna
tives
ksi
R h
giH
la
noi
tid
arT
snoit
casn
art
troh
Sst
nuoc
ca k
naBC
orporate and government bonds
Margin transactions
snoit
po k
cot
Skc
ots
nom
moC
seiti
dom
moC
kcot
s de
rref
erP
slat
em
suoi
cerP
sdnu
f lau
tuM
seno
tsme
G e
tats
e lae
R
Coins/antiques/collectibles
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281
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Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.5 Sample Common-Stock Transaction for General Mills
Sample Common-Stock
Transaction for General Mills
Source: Price data and dividend amounts were taken from the Yahoo Finance website, http://fi nance.yahoo.com, accessed October 26, 2008.
dloS nehW nruteRdesahcruP nehW tsoC
100 shares @ $48 $4,800 100 shares @ $64 $6,400
Plus commission + 55 Minus commission – 70
Total investment $4,855 Total return $6,330
Transaction Summary
033,6$nruter latoT
Minus total investment –4,855
574,1$elas kcots morf tiforP
Plus total dividends (3 years) + 455
039,1$noitcasnart siht rof nruter latoT
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282
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.2 Reading Stock Quotations
Reading Stock Quotations
Source: Wall Street Journal, October 28, 2008, p. C9.
1. Name (often abbreviated) of the corporation: Heinz2. Ticker symbol or letters that identify a stock for trading: HNZ3. Close is the price paid in the last transaction of the day: $39.454. Difference between the price paid for the last share sold today and the price paid for the last share sold on the previous day: –0.04 (in Wall Street terms, Heinz “closed down $0.04” on this day).
STOCK
HeinzHellenicHelmPayne
(SYM)
HNZOTEHP
39.455.65
25.14
–0.04–0.34–2.28
CLOSENETCHG
STOCK (SYM) CLOSENETCHG
Heinz
Hellenic
HelmPayne
HNZ
OTE
HP
39.45
5.65
25.14
–0.04
–0.34
–2.28
1 2 3 4
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283
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.3 Reading Bond Quotations
Reading Bond Quotations
Source: The Yahoo! Finance bond website: at http://bonds.yahoo.com, accessed October 28, 2008.
OVERVIEW
1. Price
2. Coupon (%)
3. Maturity Date
4. Yield to Maturity (%)
5. Current Yield (%)
6. Fitch Ratings
7. Coupon Payment Frequency
8. First Coupon Date
9. Type
10. Callable
86.57
5.600
15-Mar-2018
7.605
6.468
A
Semi-Annual
15-Nov-2008
Corporate
No
Price quoted as a percentage of the face value: $1,000 × 86.57% = $865.70
Coupon (%) is the rate of interest: 5.600 percent
Maturity Date is the date when bondholders will receive repayment: March 15, 2018
Yield to Maturity (%) takes into account the relationship among a bond’s maturityvalue, the time to maturity, the current price, and the amount of interest: 7.605 percent
Current Yield (%) is determined by dividing the dollar amount of annual interest bythe current price of the bond: ($56 ÷ $865.70 = 0.06468 = 6.468 percent)
Fitch Ratings is used to assess risk associated with this bond: A
Coupon Payment Frequency tells bondholders how often they will receive interestpayments: Semi-Annual
First Coupon Date: November 15, 2008
Type: Corporate
Callable: No
AT&T INC
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
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284
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.4 Reading Mutual Fund Quotations
Reading Mutual Fund
Quotations
Source: Wall Street Journal, October 28, 2008, p. C11.
FUND
US SmCpValDodge & CoxBalancedIncomeIntl StkStock
13.81
48.1611.2220.9769.65
–0.57
–1.11–0.02–1.27–2.36
–41.6
–38.1–6.5
–54.4–47.1
NAVNETCHG
YTD%RET
US Sm CpVal
Dodge & Cox
Balanced
Income
Intl Stk
Stock
13.81
48.16
11.22
20.97
69.65
–0.57
–1.11
–0.02
–1.27
–2.36
–41.6
–38.1
–6.5
–54.4
–47.1
1. The name of the mutual fund: Dodge & Cox Income2. The net asset value (NAV) is the value of one share of the Dodge & Cox Income Fund: $11.223. The difference between the net asset value today and the net asset value on the previous trading day: –0.02 (in Wall Street terms, the “Dodge & Cox Income fund closed down $0.02” on this day)4. The YTD% RET gives the total return for the Dodge and Cox Income fund for the year to date: –6.5%
1
FUND NAVNETCHG
YTD%RET
2 3 4
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.A Chapter Outline
Chapter 20 Outline
Understanding Personal Finances and Investments
Preparing for an Investment Program
– Managing Your Personal Finances
– Investment Goals
– A Personal Investment Program
– Important Factors in Personal Investment
How Securities Are Bought and Sold
– The Primary Market
– The Secondary Market
– The Role of an Account Executive
– Regulation of Securities Trading
Traditional Investment Alternatives
– Portfolio Management
– Asset Allocation, the Time Factor, and Your Age
– Bank Accounts
– Corporate and Government Bonds
– Common Stock
– Preferred Stock
– Mutual Funds
– Real Estate
High-Risk Investment Techniques
– Selling Short
– Buying Stock on Margin
– Other High-Risk Investments
Sources of Financial Information
– The Internet
– Financial Coverage of Securities Transactions
– Other Sources of Financial Information
– Security Averages
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286
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.B Class Exercise
Class Exercise
Rank the following investments on the
factors of safety, income, growth, and
liquidity. (7 = highest; 1 = lowest)
INVESTMENT SAFETY INCOME GROWTH LIQUIDITY
1. Bank
accounts
2. Selling
short
3. Commod-
ities
4. Govern-
ment
bonds
5. Buying
stock on
margin
6. Common
stock
7. Real estate
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.C Debate Issue
Debate Issue
Should you use a full-service broker
or a discount broker?
FULL-SERVICE
BROKER
• Since small investors
need all the help they
can get, they should
use a full-service
broker.
• Full-service brokers
can provide detailed
research information
that can provide the
edge that small
investors need.
• The added services
provided by full-service
brokers are worth the
commissions they
charge.
DISCOUNT
BROKER
• Since small investors
invest their own money,
they should make their
own decisions.
• Some brokerage fi rm
reports are biased.
Also, reliable
information is available
on the Internet, at the
public library, or from
discount brokers.
• Small investors can
save money by using
discount brokers. Also,
most small investors do
not need all the services
that full-service brokers
offer.
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.D Chapter Quiz
Chapter Quiz
1. A fi nancial statement that lists your personal assets, liabilities, and net worth is the a. retained earnings statement. b. personal income statement. c. personal balance sheet. d. personal asset sheet. e. risk-return statement.
2. __________ and risk are two sides of the same coin. a. Income b. Safety c. Liquidity d. Growth e. Investment
3. A(n) __________ market is a market in which an investor purchases fi nancial securities (via an investment bank) directly from the issuer of those securities. a. institutional b. third c. exchange d. primary e. secondary
4. A(n) __________ order to buy or sell a security lets the broker decide when to execute the transaction and at what price. a. market b. limit c. exchange d. discretionary e. monitored
5. When investors pay no sales charges to buy or sell a mutual fund, they have invested in a a. contingent deferred fund. b. no-load fund. c. load fund. d. restricted fund. e. managed index.
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.E Suggestions to Help You Accumulate the Money Needed to
Fund an Investment
Suggestions to Help You Accumulate
the Money You Need to Fund an
Investment Program
1. Pay yourself fi rst. (Pay your monthly
bills, save a reasonable amount of
money, and use whatever money is left
over for personal expenses.)
2. Take advantage of employer-sponsored
retirement programs.
3. Participate in an elective savings
program and have money deposited in a
savings account or an investment
account.
4. Make a special savings effort one or two
months each year.
5. Take advantage of gifts, inheritances,
and windfalls.
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290
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.F Four Important Factors in Personal Investment
Four Important Factors in
Personal Investment
SAFETY
This factor in an investment means
minimal risk of loss
INCOME
This factor in an investment means
a predictable source of income
each year
GROWTH
This factor means that an investment will increase or
appreciate in value
LIQUIDITY
This factor means the ease with
which an investment can be
converted to cash
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Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.G Mutual Fund Terminology
Mutual Fund Terminology
CLOSED-END FUNDS sell shares to investors only when the fund is originally organized.
OPEN-END FUNDS issue and sell new shares to any investor who requests them.
EXCHANGE-TRADED FUND is a fun that invests in the stocks contained in a specifi c stock index and whose shares are traded on a stock exchange.
NET ASSET VALUE (NAV) per share is equal to the current market value of their mutual fund’s portfolio minus the mutual fund’s liabilities, divided by the number of outstanding shares.
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