Mutual funds

Mutual Funds,
Pension Funds &
Mortgage Financing
Presented by:
Maksudul Huq Chowdhury

What is Mutual Fund
 Mutual funds are a type of investment that takes money from
many investors and uses it to make investments based on a
stated investment objective. Each shareholder in the mutual
fund participates proportionally (based upon the number of
shares owned) in the gain or loss of the fund.

Why do People Invest in Mutual Funds?
 Mutual funds offer investors an affordable way to diversify their
investment portfolios.
 Mutual funds allow investors the opportunity to have a financial
stake in many different types of investments.
 These investments include: stocks, bonds, money markets, real
estate, commodities, etc.

 Individually, an investor may be able to own stock in a few
companies, a few bonds, and have money in a money market
account. Participation in a mutual fund, however, allows the
investor to have much greater exposure to each of these asset
classes.
 Most mutual funds are professionally managed by an
investment expert known as a portfolio manager.

 This individual makes all of the buying and selling decisions for
the fund.
 There are thousands of different mutual funds in the United
States.
 This provides investors with many options to help them achieve
their investment objectives.

Basic Mutual Fund Categories
Mutual Funds can be divided into few basic categories based
upon the funds investment objective. These categories are:
Money Market Mutual Funds
Stock Mutual Funds
Index Funds
Bond Mutual Funds
Balanced Mutual Funds

1. Money Market Mutual Funds
 This is the most conservative type of mutual fund.
 Invests in high-quality, short-term securities.
 MMMF’s are an appropriate place for savings.
 These funds have typically offered higher interest rates than
bank savings accounts.

2. Stock Mutual Funds
 Type of fund that invests in stocks.
 These funds are also known as equity funds.
 There are many different types of stock mutual funds.
 Some of the most common include:
 Large-cap funds, mid-cap funds, small-cap funds, income funds,
growth funds, value funds, blend funds, international funds,
and sector funds.

3. Index Funds
 These are mutual funds whose holdings aim to track the
performance of a specific stock market index.
 Index funds also track bonds, real estate, and other types of
assets.
 These funds are lower cost than other types of funds.

4. Bond Mutual Funds
 Type of mutual fund that invests in bonds.
 There are different types of bond mutual funds.
 Typically, bond mutual funds have the objective of providing
stable income with minimal risk.

5. Balanced Mutual Funds
 These are also known as hybrid funds.
 These mutual funds invest in stocks, bonds, and money
markets.
 These are very diversified mutual funds. The stock portion of
the fund provides the potential for capital appreciation, while
the bond and money market portion provide income.

Load v. No Load Mutual Funds
 A mutual fund that charges a commission to cover its
administrative costs is called a load fund.
 A front-end load charges the load when the shares are
purchased, while a back-end load charges the load when the
shares are sold.
 A no-load mutual fund doesn’t charge a purchase or sales
commission.

Advantages of Mutual Funds
1. Professional Management
2. Diversification
3. Convenient Administration
4. Return potential
5. Low cost
6. Liquidity
7. Transparency
8. Flexibility
9. Choice of schemes
10. Well regulated
11. Tax benefits

How do I make money from a mutual fund?
1. Capital appreciation:
 As the value of securities in the fund increases, the fund's unit price
will also increase. You can make a profit by selling the units at a
price higher than at which you bought
2. Coupon / Dividend Income:
 Fund will earn interest income from the bonds it holds or will have
dividend income from the shares

How do I make money from a mutual fund?
3. Income Distribution:
 The fund passes on the profits it has earned in the form of
dividends
Disclaimer
 As the value of securities in the fund increases, the fund's unit price
will also increase. You can make a profit by selling the units at a
price higher than at which you bought. Although Mutual Fund does
not guarantee the same.

Pension Fund
A pension fund is an asset pool that accumulates over an
individual’s working years. Pension plans provide a savings plan
for employees that can be used for retirement. There are four
ways to increase the amount of money in the fund:
1. New contributions by the employee sponsored
2. New contribution by the employer on behalf of the employee
3. Dividends or interest earned by the fund that is due to its
investment in equity or debt securities
4. Appreciation in the values (capital gain) of the securities in which
the fund has invested.

Types of Pension
Pension plan can be categorized in several ways.
They may be:
(A). defined-benefit or defined-contribution, and
(B). they may be public or private.

A. defined-benefit or defined-contribution
Defined-Benefit Plan
Under a defined-benefit plan, the employer promises the
employees a specific benefit when they retire. The payout is
usually determined with a formula that uses the number of
years worked and the employee’s final salary.
For example, a pension benefit may be calculated by the
following formula:
Annual payment = 2% * average of final 3 years’ income * year of
service

In this case, if a employee had been employed for 35 years and
the average wages during the last three years were BDT. 50,000,
the annual benefit would be
 2% * BDT. 50,000.00 * 35 = BDT. 35,000 per year
 The defined-benefit plan puts the burden on the employer to
provide adequate funds to ensure that the agreed payments can be
made.
 The payments are dependent on salary level, retirement ages etc.

 External audits of pension plans are required to determine whether
sufficient funds have been contributed by the company.
 If sufficient funds are set aside by the firm for this purpose, the plan
is fully funded, if more than required funds are available, the plan is
over-funded. In most cases, insufficient funds are available and the
plan is under-funded.

Defined-Contribution Plans:
A defined-contribution plan provides benefits that are
determined by the accumulated contributions and the fund’s
investment performance. Employer of defined-contribution
plans usually put a fixed percentage of each employee’s wages
into the pension fund at each pay period. In most cases, the
employee also contributes to the funds assets.
This type of plan, a firm knows with certainty the amount of
funds to contribute.

B. Private and Public Pension Plans
Private Pension Plans
 Private pension plans are created by private agencies, including
industrial, labor, service, non-profit, charitable and educational
organizations. Some pension funds are so large that they are
major investor in corporate securities.

B. Private and Public Pension Plans
Public Pension Plans
A public pension funds is one that is sponsored by a government
body. Public pension plans are funded on a pay-as-you-go basis
– money that employees contribute today pays benefits to
current recipients. Future generations will be called on to pay
benefits to the individuals who are currently contributing.

Mortgage Markets
A mortgage is a form of debt that finances investment in property
 The debt is secured by the property
 The mortgage is the difference between the down payment and the
value to be paid for the property

Mortgage Markets
Financial institutions such as savings institutions and
mortgage companies originate mortgages
 They accept mortgage applications and assess the
creditworthiness of the applicants
 The mortgage contract specifies the mortgage rate, the
maturity, and the collateral that is backing the loan
 The originator charges an origination fee
 The originator may earn a profit from the difference
between the mortgage rate and the rate that it paid to
obtain funds

Mortgage Characteristics
The mortgage contract should specify:
 Whether the mortgage is federally insured
 The amount of the loan
 Whether the interest rate is fixed or adjustable
 The interest rate to be charged
 The maturity
 Other special provisions

Insured versus conventional mortgages
Fixed-rate versus adjustable-rate mortgages
 A fixed-rate mortgage locks in the borrower’s interest rate
over the life of the mortgage
 The periodic interest payment is constant
 Financial institutions that hold fixed-rate mortgages are
exposed to interest rate risk if funds are obtained from
short-term sources
 Borrowers with fixed-rate mortgages do not benefit from
declining rates

An adjustable-rate mortgage (ARM) allows the mortgage rate to
adjust to market conditions
 The formula and frequency of adjustment vary among mortgage contracts
 A common ARM uses a one-year adjustment with the interest rate tied to the
average T-bill rate over the previous year
 Some ARMs contain an option that allows mortgage holders to switch to a
fixed rate within a specified period
 Most ARMs specify a maximum allowable fluctuation in the mortgage rate
per year and over the mortgage life
 Borrowers with ARMs face uncertainty about future interest rates

Amortizing mortgages
 An amortization schedule shows the monthly payments broken down into
principal and interest
 During the early years of a mortgage, most of the payment reflects interest
 Over time, the interest proportion decreases
 The lending institution for a fixed-rate mortgage will receive a fixed amount
of equal periodic payments over a specified period of time
 The payment amount depends on the principal, interest rate, and maturity

Types of Mortgage Financing
1. Graduated-payment mortgages
2. Growing-equity mortgages
3. Second mortgages
4. Shared-appreciation mortgages

1. Graduated-payment mortgage
 Allows the borrower to initially make small payments
 Results in increased payments over the first 5 to 10 years, at
which time payments level off
 Is tailored for families who anticipate higher income

2. Growing-equity mortgages
 Allows the borrower to initially make small payments
 Results in continually increasing payments over time
 Results in a relatively short payoff time

3. Second mortgages
 Can be used in conjunction with the primary or first mortgage
 Often has a shorter maturity than the first mortgage
 Has a higher interest rate than the first mortgage because of
increased default risk
 Is often offered by sellers of homes

4. Shared-appreciation mortgages
 Allows a home purchaser to obtain a mortgage at a below-
market interest rate
 Allows the lender to share in the price appreciation of the home

Risk from Investing in Mortgages
1. Interest rate risk
 Mortgage prices decline in response to an increase in interest
rates
 Mortgages are commonly financed by financial institutions with
short-term deposits
 Mortgages can generate high returns when interest rates fall, but
gains are limited because borrowers tend to refinance

2. Prepayment risk
 Prepayment risk is the risk that a borrower may prepay the
mortgage in response to a decline in interest rates
 The investor receives payment and has to reinvest at the lower
interest rate
 Limiting exposure to prepayment risk
 Financial institutions can sell loans shortly after originating
them or invest in adjustable-rate mortgages

3. Credit risk
 Credit risk is the possibility that borrowers will make late payments
or even default
 The probability of default is influenced by economic conditions
and by:
 The level of equity invested by the borrower
 The borrower’s income level
 The borrower’s credit history
 Limiting exposure to credit risk
 Financial institutions can purchase insurance
 Financial institutions can maintain the mortgages they originate

Mutual funds

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