Mutual Funds

Mutual funds are the most widely held type of pooled investment. Understanding the two structural types (open-end and closed-end) is essential because the exam frequently tests the pricing and trading differences between them.

Open-End Funds

Open-end funds are what most people mean when they say "mutual fund." They are the most common type of investment company.

• Continuous offering: The fund issues new shares and redeems existing shares on demand; there is no fixed number of shares
• Pricing at NAV: Shares are bought and sold at net asset value (NAV), calculated once per day after the market closes
• NAV formula: $\text{NAV} = \frac{\text{Total Assets} - \text{Total Liabilities}}{\text{Shares Outstanding}}$
• Forward pricing: Securities and Exchange Commission (SEC) Rule 22c-1 requires that all buy and sell orders execute at the next calculated NAV - you cannot lock in today's price for a future order
• Transaction with the fund: Investors buy from and sell back to the fund company directly (not on an exchange)
• Load vs. no-load: May charge a sales charge (load) or be no-load
• Professional management: Managed by a registered investment adviser

Key characteristics:

• Highly liquid; can redeem shares any business day
• Price always equals NAV (no premiums or discounts)
• Portfolio changes as manager buys and sells securities
• Share count fluctuates as investors enter and exit

Exam Tip: Gotchas

• Forward pricing applies only to open-end funds. All orders execute at the next calculated NAV - you cannot trade at a stale price.
• A "closed fund" is NOT a closed-end fund. A closed fund is simply an open-end fund that has temporarily stopped accepting new investors.

Closed-End Funds

Closed-end funds have a fundamentally different structure from open-end funds.

Think of it this way: An open-end fund is like a restaurant that makes food to order, where each customer gets a fresh plate (new shares created at NAV). A closed-end fund is like a limited-edition sneaker drop: once the initial batch sells out, you have to buy from someone else on the secondary market, and the price depends on how badly people want them.

• Fixed shares via IPO: Issue a fixed number of shares through an initial public offering; the fund does not create or redeem shares after that
• Exchange-traded: Shares trade on stock exchanges like individual stocks throughout the trading day
• Market price differs from NAV: Price is determined by supply and demand, not by the underlying portfolio value
  • Trades at a premium when market price > NAV
  • Trades at a discount when market price < NAV
• Leverage: May borrow to invest, which amplifies both gains and losses
• Less liquid than open-end funds; must find a buyer on the exchange

Exam Tip: Gotchas

• Closed-end funds can use leverage; open-end funds generally cannot. Leverage amplifies both gains and losses, adding a risk layer that open-end funds avoid.
• Closed-end shares trade on exchanges, so you need a buyer to exit. Open-end shares are redeemed directly with the fund company.

Open-End vs. Closed-End: Side-by-Side

Exam Tip: Gotchas

• Open-end = always at NAV. Closed-end = market price. This pricing distinction is frequently tested. If a question mentions shares trading at a premium or discount, it is describing a closed-end fund.