Mutual Funds

Both structures pool investor money into a single managed portfolio, but only one creates and redeems shares on demand. Later units compare mutual funds against UITs and ETFs, so lock in the open-end/closed-end distinction first.

What Are 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: All buy and sell orders execute at the next calculated NAV (not the prior day's 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 to open-end funds (and UITs, which also redeem at NAV). All orders execute at the next calculated NAV - you cannot trade at a stale price. Closed-end funds and ETFs trade at market price instead.
• 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.

What Are 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
  • The premium or discount is always sized against NAV, not against the market price: Premium/Discount % = (Market Price − NAV) ÷ 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

Example: NAV is $30.00 and the market price is $33.00. The fund is trading at a premium, and the premium is $3.00. As a percentage, that is $3.00 ÷ $30.00 NAV = 10%, not $3.00 ÷ $33.00 market price.

Exam Tip: Gotchas

• Both fund types can use leverage within limits. Open-end funds may borrow from banks; closed-end funds have broader financing options, including issuing preferred shares. Leverage amplifies both gains and losses.
• Closed-end shares trade on exchanges, so you need a buyer to exit. Open-end shares are redeemed directly with the fund company.
• NAV is always the denominator for a premium or discount percentage, never the market price. Dividing by the market price instead gives a different, wrong number (here, 9.09% instead of 10%).

How Do Open-End and Closed-End Funds Compare?

Exam Tip: Gotchas

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

What Should You Check on Exam Day?

• Open-end funds price and trade at NAV directly with the fund company; closed-end funds trade on an exchange at a market price that can sit above (premium) or below (discount) NAV.
• Forward pricing (next calculated NAV) applies to open-end funds and UITs; closed-end funds and ETFs trade at market price instead.
• Closed-end funds can issue preferred shares to leverage the portfolio; open-end funds may borrow from banks within limits.
• A "closed fund" (an open-end fund that stopped accepting new investors) is not the same thing as a closed-end fund.