Chapter 14, Problem 2PA

Summary Introduction

(a)

To determine:

The lower cost alternative to purchase.

Introduction:

Mutual fund refers to the fund that is managed by the professionals and consists of the pool of money from various different investors in order to purchase different and various securities.

Explanation of Solution

Purchase of electronic trade funds (ETF) is relatively cheaper as compared to the regular mutual fund.

ETF has a lower ratio of expense.

Annual expense of electronic trade fund is less costly as it has percent of 0.25%.

Conclusion

Hence, Electronic trade funds are cheaper.

Summary Introduction

(b)

To determine:

The lower cost to own 6 months.

Explanation of Solution

Given,

Annual gain is 7%.

Investment holding time is 6 months,

Cost of mutual funds purchasing is 0.85%.

Cost of EFT annual expense is 0.25%

Transaction cost is $20.

Consider the value of investment to $10,000.

Formula to calculate cost of purchasing the mutual fund,

$\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}$

Substitute 0.85% for expense ratio and $10,000 for value of asset.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=0.0085\times \$10,000\\ =\$85\end{array}$

Cost of purchasing mutual funds is $85.

Formula to calculate cost of purchasing electronic trading fund,

$\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left[\begin{array}{l}\left(\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}\right)\\ +\text{Transaction}\text{}\text{fee}\end{array}\right]$

Substitute 0.25% for the expense ratio, $10,000 for the value of the asset and $20 for the transaction fee.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left(0.025\%\times \$10,000\right)+\$20\\ =\$45\end{array}$

Cost of purchasing ETF is $45.

Conclusion

Hence, Cost of purchasing ETF is quite less compared to mutual funds.

Summary Introduction

(c)

To determine:

The lower cost to own 2 years.

Explanation of Solution

Given,

Annual gain is 10%.

Investment holding time is 6 months,

Cost of mutual funds purchasing is 0.85%.

Cost of EFT annual expense is 0.25%

Transaction cost is $20.

Consider the value of investment to $10,000.

Formula to calculate cost of purchasing the mutual fund,

$\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}$

Substitute 0.85% for expense ratio and $10,000 for value of asset.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=0.0085\times \$10,000\\ =\$85\end{array}$

Cost of purchasing mutual funds is $85.

Formula to calculate cost of purchasing electronic trading fund,

$\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left[\begin{array}{l}\left(\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}\right)\\ +\text{Transaction}\text{}\text{fee}\end{array}\right]$

Substitute 0.25% for the expense ratio, $10,000 for the value of the asset and $20 for the transaction fee.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left(0.025\%\times \$10,000\right)+\$20\\ =\$45\end{array}$

Cost of purchasing ETF is $45.

Conclusion

Hence, Cost of purchasing ETF is quite less compared to mutual funds.

Summary Introduction

(d)

To determine:

The lower cost to own 2 years.

Explanation of Solution

Given,

Annual loss is 10%.

Investment holding time is 6 months,

Cost of mutual funds purchasing is 0.85%.

Cost of EFT annual expense is 0.25%

Transaction cost is $20.

Consider the value of investment to $10,000.

Formula to calculate cost of purchasing the mutual fund,

$\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}$

Substitute 0.85% for expense ratio and $10,000 for value of asset.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{mutual}\text{funds}=0.0085\times \$10,000\\ =\$85\end{array}$

Cost of purchasing mutual funds is $85.

Formula to calculate cost of purchasing electronic trading fund,

$\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left[\begin{array}{l}\left(\text{Expense}\text{ratio}\times \text{Value}\text{of}\text{asset}\right)\\ +\text{Transaction}\text{}\text{fee}\end{array}\right]$

Substitute 0.25% for the expense ratio, $10,000 for the value of the asset and $20 for the transaction fee.

$\begin{array}{c}\text{Cost}\text{of}\text{purchasing}\text{electronic}\text{trading}\text{fund}=\left(0.025\%\times \$10,000\right)+\$20\\ =\$45\end{array}$

Cost of purchasing ETF is $45.

Conclusion

Hence, Cost of purchasing ETF is quite less compared to mutual funds.