Answers to Chapter 17 Questions

1. A mutual fund represents a pool of financial resources obtained from individuals and invested in the money and capital markets. It represents another way for those with extra funds to channel those funds to those in need of extra funds.

2. Investing in mutual funds allows an investor to achieve a greater level of diversification than could likely be achieved by investing in individual stock on one's own account. A single share of a mutual fund could represent ownership in over a thousand different companies. Whereas the investment in the mutual fund might cost one hundred dollars, buying over a thousand individual shares of stock could cost over one hundred thousand dollars. Further, since mutual funds can buy and sell securities in large blocks, its trading cost are much lower than those of the individual investor buying a few shares at a time.

3. Money market mutual funds (MMMFs) invest in assets that have maturities of less than one year. These assets primarily are Treasury bills, negotiable certificates of deposit, repurchase agreements, and commercial paper. The growth in MMMFs during the late 1970s and early 1980s occurred because of rising interest rates in the money markets while rates in depository institutions were restricted by Regulation Q. Many investors moved their short-term savings from the depository institutions to the MMMFs as the spread in the earnings rate reached double digits.

4. Long-term mutual funds primarily invest in assets that have maturities of more than one year. The most common assets include long-term fixed-income bonds, common stock, and preferred stocks. Some money market assets are included for liquidity purposes. The growth in these funds in the 1990s and early 2000s reflected the dramatic increase in equity returns. The reduction in transaction costs, and the recognition of