Question

You invest $10,000 each in two separate funds. The first fund is the HeavyLoad (HL) Fund which has a front-end load of 6% and a back-end load of 2%. The fund's annual expense ratio is 1.21%. The second fund is the Performance (PER) Fund which has no front or back end loads, but the annual expense ratio is 5%. After you liquidate your holdings, you end up with identical amounts coming in from both funds. HL’s annual return over your investment period has been 14%.

A) What annual return must have PER generated if you invested for 1 year?

B) What annual return must have PER generated if you invested for 10 years?

C) In order to keep up with HL’s performance, what need

Answer 1

Front end laod is charged at the time of investing in mutual fund.

Back end laod is charged at the time of selling the mutual fund.

Annual expense ratio decreases the overall return to investors by the expense ratio.

A: annual returnPER generated in 1 year

HL Fund
Amount	10,000
front-end load	6.00%
Actual investment	9,400	=10000*(1-0.06)
expense ratio	1.21%
Annual return	14.00%
Annual return received by investor	12.79%	=14.00-1.21
Amount received in 1 yr	10,602	=9400*(1+12.79%)
Back-end load	2.00%
Back-end load cost	212
Final amount received	10,390
PER Fund
Amount	10,000
front-end load	0%
Actual investment	10,000	=10000*(1-0)
expense ratio	5.00%
Amount received in 1 yr	10,390	=same as HL fund
annual return received	3.90%	=(10390-10000)/10000
annual return generated	8.90%	=3.90+5.00

B: annual returnPER generated in 10 years

HL Fund
Amount	10,000
front-end load	6.00%
Actual investment	9,400	=10000*(1-0.06)
expense ratio	1.21%
Annual return	14.00%
Annual return received by investor	12.79%	=14.00-1.21
Amount received in 10 yrs	31,320.87	=9400*((1+12.79%)^12)
Back-end load	2.00%
Back-end load cost	626
Final amount received	30,694
PER Fund
Amount	10,000
front-end load	0%
Actual investment	10,000	=10000*(1-0)
expense ratio	5.00%
Amount received in 10 yrs	30,694	=same as HL fund
annual return received	11.87%	=((30694/10000)^(1/10))-1
annual return generated	16.87%	=11.87+5.00

C. In order to keep up with HL's performance, PER needs to earn a higher annual return since its net expense over a longer period of time is higher.