Question 1 Mutual fund investors with very long time horizons (holding periods)

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Question 1 Mutual fund investors with very long time horizons (holding periods) are more likely to prefer higher fees in the form of C a. 12b-1 Fees b. Back-End Loads c. Front-End Loads d. Operating Expense Ratios e. Other Annual Expenses C The form of performance analysis examining the largest potential loss from a peak in fund or asset performance to the deepest trough within a specified time interval is known as C a. Attribution Analysis C b. Max Drawdown Analysis C c. Sensitivity Analysis d. Technical Analysis e. Trevnor Measure Pepco Holdings (POM) is expected to issue a cash dividend in one years time of $1.10/share POM s cost of common equity capital is 10% and it is expected to grow earnings and dividends by 2% per year. According to the dividend discount model (ie. Gordon (constant) growth model approximately what should the price per share of POM common stock be? Ca. $1.10 b. $11.00 c. $13.75 d. $22.00 C e. $55.00 C C

Explanation / Answer

1. If an investor prefers to hold the mutual fund over the longer period, he would prefer a higher fees in the form of back-end load. The backend load refers to the load which is applicable at the time of selling. Using the same time value of money concept, the investor would prefer paying the load or cost at a later date rather than on a yearly or immediate basis. he would rather invest the amount to earn returns untill the period. Hence, the answer is b. Back-end loads

2. Max draw down analysis conducts an analysis of how low can the investment dip in the worst case scenario. It helps ascertain the maximum risk that the investment could undergo within the specified period under consideration. It measures the largest single drop of the investment or portfolio from the peak to trough. The answer is b. Max draw down analysis

3. Gordon constant growth model is obtained using the formula = D1 / ke - g (D1 is the dividend in next year; Ke is cost of common equity; g is growth of dividends and earnings). All these variables are given in the problem statement -

D1 = 1.1; Ke = 10%; g = 2%

Substituting in the above equation = 1.1 / 10% - 2% = 13. 75

Hence, answer is option C 13.75

4. Diversification is where the portfolio adds asset classes and investments which are not positively correlated and are of varied groups. There can be diversification across asset classes, sub - asset classes and investements with these sub-assets. For example, equity and debt are asset classes, within equity we could have mutual funds, stocks and within mutual funds we could choose index funds, growth funds etc., In the above case, Global Total Bond and equity index fund offers the maximum diversification because, it is a global fund which means it invests across various countries, it has both bond and equity asset classes and also is an index fund. Index refers to a wide group of stocks or bonds which represent the general direction of the market. Hence the answer is option b. Global Total Bond and equity index fund

5. There is a need to vary the distribution of your portfolio in accordance to the market movement, this is called the portfolio strategy. The strategy for the portfolio will be provided as part of the prospectus and will be inline with the objective of the portfolio. Typically, one would reduce the risky investments when the markets are looking bearish (downtrend) and increase the exposure towards risky investments when the markets are looking bullish (uptrend), the ranges of exposure would be pre-determined and mentioned in the prospectus. This method is dynamic asset allocation and is also termed as strategic asset allocation. Hence, the option is d. Strategy Asset Allocation.

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