Question

Part I. [30pts] For Problems 1 through 10, answer whether or not the statement is True (T) or False (F). Briey justify your answer.
Problem 1. (3pt) Hedge fund is a special sort of mutual fund.
Problem 2. (3pt) ETFs are not involved with active investment strategies.
Problem 3. (3pt) Most mortgage loans once had balloon payments; now most current mortgage loans fully amortize.
Problem 4. (3pt) In the bond market, the bond supply is more sentitive to negative macroeconomic shocks than the bond demand.
Problem 5. (3pt) The stock market crash of 1929 made almost zero impact on mutual fund industry because the main eect was on the stock market and not on the mutual fund market.
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Problem 6. (3pt) New issuances in bonds were typically more than the new issuances of stocks during the past 30 years.
Problem 7. (3pt) In the long run, stock market indexes grow as the GDP growth and ination.
Problem 8. (3pt) Stocks and bonds are two of the most important source of external nancing for businesses.
Problem 9. (3pt) The mortgate interest rate has fallen during the last 30 years as the long-term treasury rates fell.
Problem 10. (3pt) The Investment Company Act of 1940 reinvigorated the mutual fund industry by providing government deposit guarantee for the mutual funds which is similar to that of FDIC.

Answer 1

1. False - Hedge fund is not a special sort of mutual fund.

Hedge funds and mutual funds can seem similar from a cursory glance, but the two are actually wildly different beasts.

Mutual funds	Hedge funds
Don't take share from the profit Are available to the general public Charge a management fee (normally 1- 2%) Can't make high-risk investments Tend to perform worse than hedge funds	Take ~20% performance fee from the profit Are available only to high-net-worth and sophisticated investors Charge management fee (normally 2%) plus performance fee (normally 10–30%) Can make high-risk investments Tend to perform better than mutual funds

2. True - ETFs are not involved with active investment strategies.

Active investing involves paying a human to buy and sell individual stocks regularly through mutual funds. A passive investing strategy involves investing in index ETFs rather than picking stocks. Active investing aims to beat the market where as passive investing aims to track the market.

3. True

Most mortgage loans once had balloon payments; now most current mortgage loans fully amortize. Balloon loans - require that a large payment be made to pay off the remaining balance Amortizing loans - structured so that equal monthly payments made such that the total of all payments cover both interest and principal over the life of the loan.

4. False

In the bond market, the bond demand  is more sentitive to negative macroeconomic shocks than the bond supply.

5. False - Positive impact on MF

The stock market crash of 1929 & the resulting Great Depression that put the focus on the then new revolution called mutual funds. The market crash engendered new regulations for the equities market, including the Securities Exchange Act of 1934 which had many safeguards designed to protect investors (like reporting of quarterly filings). These regulations also favoured mutual funds for their inherent diversification.

6. True

Interest on bonds and other debt is deductible on the corporation's income tax return while the dividends on common stock are not deductible on the income tax return. Since bonds are a form of debt, the existing stockholders' ownership interest in the corporation will not be diluted. Therefore, the future gains from use of the bond proceeds (minus the bond interest payments) will flow to the stockholders. This is related to the concept of leverage or trading on equity.

7. True

In a theoretical environment stock price increases should exactly match real GDP growth. The underlying economy of a country translates into a company’s profits, thus into Earnings per Share (EPS), which eventually determines the price of a company’s stock. However, this only works if a country’s economy is closed, valuations remain constant and if only domestic companies are listed on a country’s stock market. In theory, and over the long-term, aggregate corporate earnings rise when the economy grows or vice versa.

8. True

External sources of finance are those sources of finance which come from outside the business. For example, retained earnings are an internal source of finance whereas bank loan is an external source of finance. Equity shares are a common source of finance for big companies. A key feature of equity share is the ‘sharing of ownership rights’ and therefore, the current shareholders’ rights are diluted to some extent. Debentures/Bonds are another common means of finance used by companies who prefer debt over the equity. Debt is considered to be the cheaper mode of finance compared to equity. It does not share control with investors. It is because the interest paid to debenture/bond holders is tax deductible.

9. True

There is a strong correlation between mortgage interest rates and Treasury yields, according to a plot of 30-year conventional mortgages and 10-year Treasury yields using Federal Reserve Economic Data. Rising yields lead to higher mortgage interest rates. Yields rise usually when the Federal Reserve raises short-term rates to control inflation and slow down the pace of economic growth. Higher mortgage interest rates mean higher monthly mortgage payments, which slows down the real estate market as home buyers put off buying new homes or upgrading to larger homes. Falling Treasury yields lead to lower mortgage rates, which means lower monthly mortgage payments. Renters might consider buying homes, and existing homeowners might think of upgrading to bigger homes or refinancing their mortgages at lower rates. Mortgage rates might not always fall as rapidly as Treasury yields, especially when sustained economic weakness increases the risk of mortgage defaults.

10. False

The Investment Company Act of 1940 regulates the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations