INVESTMENT INSTITUTIONS
They collect funds by selling shares to the public.
Mutual funds/ investment companies sell to middle class savers who have a modest amount of money to invest and who have little knowledge about the operations of financial markets. Mutual funds make investments in various types of capital and money market instruments.
Capital market instruments: High graded corporate bonds (that offer high rate of interest), tax exempt Govt. bonds, etc.
Money market instruments: Certificates of deposits, commercial papers, Treasury Bills, etc.
Mutual funds maintain portfolio of various types of funds.
Index funds
Global funds
Vulture funds
Hedge funds
Index funds are used to hold a portfolio of stocks of various selected companies. It selects shares of various companies according to/ based on some criteria. Index funds buy stocks and hold in the portfolio (buy and hold strategy).
Global funds are invested in stocks and bonds traded all over the world. These funds have access to securities traded through stock exchanges around the world.
Vulture funds are used to purchase securities from firms in trouble the hope of earning exceptional returns when its valuable assets are liquidated.
Hedge funds adopt aggressive strategies and are invested in high risk securities in the hope of high returns from pursuing high risk investments.
Tax Situations of Mutual Funds:
Mutual Funds enjoy favorable tax situation. They don't have to pay taxes on income generated by their security holdings provided that:
At least 50% of the resources must be invested in securities.
They must maintain a highly diversified securities (i.e. a maximum of 25% of total funds can be invested in securities issued by any one business firm).
At most 10% of the earnings can be retained in the company and the rest must be distributed to the shareholders.
Types of Mutual Funds:
There are two types of Mutual Funds:
Open end Mutual Funds
Closed end Mutual Funds
Open end Mutual Funds sell shares in any quantity demanded by the public and the investors can redeem their shares at any time they wish.
Price of shares of Open end Mutual Funds:
The price of each open end company share is equal to the net average value of the firm.
Average Net Asset Value = (Total Assets-Total Liabilities)/Total number of shares
The average Net Asset value is the difference between Total Assets and Total Liabilities divide by the total number of shares.
Open end companies are heavily invested in common stock. It represents two-thirds of all assets. They also invest in corporate and Govt. bonds that accounts for rest of the remaining assets.
Closed end Mutual Funds can sell only a specific number of shares and that are traded on stock exchanges. To raise funds, Closed end Mutual Funds issue preferred stocks, convertible bonds and other regular bonds.
Investment companies/ Mutual Funds adopt 3 major objectives:
Growth objective
Income objective
Balanced objective
Growth objective: Funds are invested mainly in common stocks having strong growth potential to achieve long-term capital appreciation.
Income objective: Funds are invested in stocks and bonds paying high dividends and interest to gain current income.
Balanced objective: The funds are used to acquire bonds, common stock, preferred stock that offer both capital gains and current income.
Why savers prefer Mutual Funds?
Savers prefer Mutual Funds because:
There is greater price stability, so risk is reduced.
They have opportunities for capital gains
They have high liquidity because funds are invested in money market instruments.
Finance Companies
Finance companies are sometimes called departmental stores of consumer and business credits because they offer credit to businesses and consumers for a wide variety of purposes.
There are 3 types of finance companies:
Consumer finance companies
Sales finance companies
Commercial finance companies
Consumer finance companies make personal loans to individuals for the purchase of cars, home appliances, mobile phones. Also they provide customers loans for meeting expenses for health caring, education, vacations, home repairs, utility bills.
Sales finance companies provide installment loans to customers of selected dealers selling automobiles and other consumer durables. The principal function of Sales financing companies is to promote sales of products of sponsoring funds by providing credits to consumers.
Commercial finance companies are also called leasing companies. They extend credits to business firms for the purchase of productive resources such as automobiles, airplanes, ships, equipment, etc. Leasing companies purchase business equipment and other assets and lease them in return for rental fees.
Principal Sources of Funds
Leasing companies use heavy debt in financing their operation. And the principal sources of borrowed funds for leasing companies are: 1. Bank loans, 2. Commercials papers, 3. Bonds sold to banks, 4. Insurance companies and 5. Corporations. They also raise funds from real estate transactions.
Mortgage banks provide mortgage loans to business firms working on real estate development projects to finance the construction of office buildings, shopping buildings, apartment buildings, etc. They raise funds from the sale of stock and debt securities to long-term lenders such as insurance companies, pension funds, etc.
