Mutual Fund Practice Questions Solution

Problem 9

Provided Data

Stock	Shares	Price
A	200,000	Rs 35
B	300,000	Rs 40
C	400,000	Rs 20
D	600,000	Rs 25

Additional information:
– Accrued management fee: Rs 30,000
– Total shares outstanding in the fund: 4,000,000

(a) Calculate the NAV of the Fund

1. Compute Market Value of Each Holding:
   - A: 200,000 × Rs 35 = Rs 7,000,000
   - B: 300,000 × Rs 40 = Rs 12,000,000
   - C: 400,000 × Rs 20 = Rs 8,000,000
   - D: 600,000 × Rs 25 = Rs 15,000,000
2. Total Market Value of Assets:
   7,000,000 + 12,000,000 + 8,000,000 + 15,000,000 = Rs 42,000,000
3. Adjust for Accrued Management Fee:
   Net Assets = 42,000,000 - 30,000 = Rs 41,970,000
4. Determine NAV Per Share:
   NAV per share = 41,970,000 / 4,000,000 ≈ Rs 10.49

Answer (a): The NAV per share of the fund is approximately Rs 10.49.

(b) Investment Decision at Trading Price Rs 10

The market price of the closed-end fund is Rs 10, which is below the computed NAV of Rs 10.49. This implies that the shares are trading at a discount. Investors would typically find it attractive to buy shares at a discount since they are getting more intrinsic value for less.

Answer (b): You would buy shares of the fund, as they are trading at a discount relative to the NAV.

(c) Why Do Closed-End Fund Shares Differ from NAV?

Unlike open-end funds that transact at the calculated NAV, closed-end funds trade on exchanges. Their share prices are determined by market supply and demand. Factors such as investor sentiment, market liquidity, managerial reputation, and expectations of future performance can cause the trading price to deviate from the underlying net asset value.

(d) Why Are Closed-End Funds Traded at a Discount or Premium?

A closed-end fund trades at a discount when market participants are pessimistic, leading to low demand relative to the fixed number of shares. Conversely, if investors expect favorable performance or unique investment opportunities, the share price may trade at a premium. Essentially, the discount or premium reflects the market’s perception of the fund’s future prospects compared to its current underlying assets.

Problem 10

Part (a): Calculate the Rate of Return

Given:

• Beginning of Year:
  – NAV = Rs 12
  – Trading at a 2% premium → Price = Rs 12 × (1 + 0.02) = Rs 12.24
• End of Year:
  – NAV = Rs 12.1
  – Trading at a 7% discount → Price = Rs 12.1 × (1 – 0.07) = Rs 11.253
• Distribution Paid: Rs 1.5 per share

Investor’s Total Return Calculation:

1. Ending Value per Share:
   Ending Price + Distribution = Rs 11.253 + Rs 1.5 = Rs 12.753
2. Total Return:
   Return = (12.753 - 12.24) / 12.24 = 0.513 / 12.24 ≈ 0.0418 or 4.18%

Answer (a): The investor’s rate of return for the year is approximately 4.18%.

Part (b): Calculate the Fund’s Net Liabilities

Given Holdings:

• SBI Bank:
  – 100,000 shares at Rs 480 per share
  – Market Value = 100,000 × Rs 480 = Rs 48,000,000
• Investment Bank:
  – 200,000 shares at Rs 540 per share
  – Market Value = 200,000 × Rs 540 = Rs 108,000,000

1. Total Market Value of Assets:
   Rs 48,000,000 + Rs 108,000,000 = Rs 156,000,000
2. Fund’s Total NAV from Outstanding Shares:
   – There are 70,000 shares outstanding, and the reported NAV is Rs 2,000 per share.
   Total Reported NAV = 70,000 × Rs 2,000 = Rs 140,000,000
3. Net Liabilities Computation:
   Since by definition:
   NAV = Total Assets - Liabilities
   Rearranging gives:
   Liabilities = Total Assets - NAV
   Therefore,
   Liabilities = Rs 156,000,000 - Rs 140,000,000 = Rs 16,000,000

Answer (b): The fund’s net liabilities amount to Rs 16,000,000.