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MGT604 - Management of Financial Institutions - Lecture Handout 22

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Mutual funds

What are mutual funds?

An investment vehicle which is comprised of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market securities, and similar assets. Mutual funds are operated by money mangers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual
fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

In business encyclopedia

Mutual funds belong to a group of financial intermediaries known as investment companies, which are in the business of collecting funds from investors and pooling them for the purpose of building a portfolio of securities according to stated objectives. They are also known as open-end investment companies. Other members of the group are closed-end
investment companies (also known as closed-end funds) and unit investment trusts. In the United States, investment companies are regulated by the Securities and Exchange Commission under the Investment Company Act of 1940.

Mutual funds are generally organized as corporations or trusts, and, as such, they have a board of directors or trustees elected by the shareholders. Almost all aspects of their operations are externally managed. They engage a management company to manage the investment for a fee, generally based on a percentage of the fund's average net assets during
the year. The management company may be an affiliated organization or an independent contractor. They sell their shares to investors either directly or through other firms such as broker-dealers, financial planners, employees of insurance companies, and banks. Even the day-to-day administration of a fund is carried out by an outsider, which may be the
management company or an unaffiliated third party.

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MGT604 - Management of Financial Institutions - Lecture Handout 01

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Financial Environment & Role of Financial Institutions

The economic transformation under way in the former centrally planned economies (FCPEs) was motivated in part by the recognition that central planning has failed to allocate financial and real resources efficiently. This paper addresses the question of what kind of financial system should replace central planning in allocating capital and maintaining effective corporate governance during the transformation period. Financial sector reform has, at times, been portrayed as a question of adopting either a bank-based or a (securities) market-based model. In the bank-based model, commercial banks, often licensed as universal banks, take the lead in financing enterprise restructuring and investment. Proponents of the market-based model argue that the structural problems in the banking sector cannot be overcome easily; so firms will have to look to equity and bond markets for sources of new capital. Equity and bond markets in the FCPEs are not sufficiently well developed to support significant issues of new securities or to provide a mechanism for corporate control. They lack adequate liquidity, regulatory oversight, information disclosure, and clearing and payment systems. The important role of banks in maintaining the payment system and in providing credit to market participants to support trading and settlement means that until banks are restructured and recapitalized, securities market development will be constrained.

Investment funds emerging from mass privatization schemes may create concentrations of equity ownership that would allow them to play an important role in corporate control and perhaps, too, in finding sources of investment capital. They are a relatively recent innovation, however, and it remains to be seen how active they will be in financing and managing privatized enterprises.

The authorities should first establish a healthy banking sector, because it is the banks that are the most promising source of working capital and corporate control. This does not mean that securities market development should be ignored, only that it should not be a priority use of scarce government resources at the present time.

Many observers recommend that banks be given the power to act as universal banks, combining lending with securities market operations and equity investment. The potential problems associated with such a model in the FCPEs during the transformation period outweigh any potential benefits. It is recommended, therefore, that commercial banking and
investment banking activities be separated, at least until banks have demonstrated competence in their commercial lending operations.

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