Net Asset Value

An investor buys shares of a closed-end fund on an exchange from another investor. How much of the purchase price reaches the fund itself?

1. A.The full purchase price, because the fund issued those shares in the first place.Wrong. The fund was paid when the shares were first issued, and that transaction closed long ago.
2. B.None of it, because the money passes from one investor to another.Correct. Exchange purchases of closed-end shares are secondary market trades between two investors.
3. C.The purchase price less the broker's commission, which the fund retains.Wrong. The commission belongs to the executing firm, and none of the price reaches the fund in any case.
4. D.An amount equal to the fund's net asset value per share purchased.Wrong. Net asset value measures what the portfolio is worth; it is not a payment made to the fund.

Why: A closed-end fund raises capital once, in an offering of a fixed number of shares, and the money it received then is the money it invests. After that its shares trade among investors on an exchange, exactly like the shares of an operating company. Those trades are secondary market transactions, so the fund's asset base is untouched by them and its share price is set by supply and demand rather than by net asset value. Contrast an open-end fund, where every purchase sends new money to the fund itself.

The New York Stock Exchange closes early, at 1:00 p.m. Eastern time, on the Friday after Thanksgiving. Halvard Fund prices its shares as of the close of regular trading on the NYSE. Marisabel places a purchase order with the fund at 2:30 p.m. that Friday. At what price is her order executed?

1. A.At the net asset value computed on the last full trading day before the holidayForward pricing never uses a past price. Doing so would let investors trade on known values, which is exactly what the rule prevents.
2. B.At whichever of the two prices is lower, since the early close was outside her controlThere is no favorable-price provision. Every order receives the next computed net asset value, regardless of circumstances.
3. C.At that Friday's net asset value, since she placed the order before the usual 4:00 p.m. cutoffThe 4:00 p.m. figure is a convention, not a rule. The fund prices at the actual exchange close, which was 1:00 p.m. that day.
4. D.At the next net asset value computed after her order arrives, which is the following business day's priceCorrect. Her 2:30 p.m. order missed the 1:00 p.m. pricing, so forward pricing carries it to the next computed net asset value.

Why: Forward pricing means an order is executed at the next net asset value computed after the fund receives it. Halvard prices as of the NYSE close, so on an early-close day the pricing time moves to 1:00 p.m. Marisabel's 2:30 p.m. order arrives after that day's pricing and therefore receives the next computed net asset value, which is the following business day's. The clue is that the fund's pricing time is defined by reference to the exchange close rather than a fixed clock time. Review: forward pricing. Trap: assuming 4:00 p.m. is always the cutoff.

A mutual fund calculates its net asset value:

1. A.Once per business day after the closeCorrect - daily forward pricing.
2. B.Continuously throughout the dayContinuous repricing describes exchange-traded products, whose market prices move all session. A mutual fund values its portfolio once, after the close, and every order that day is filled off that single figure.
3. C.WeeklyA weekly valuation cycle belongs to illiquid vehicles that cannot mark their holdings more often. A fund that must accept purchases and redemptions every business day has to know its per-share value every business day.
4. D.Only when shares are redeemedRedemptions certainly use NAV, so the association is sound as far as it goes. The calculation does not wait for shareholder activity: purchases, exchanges, and reporting all depend on it, so NAV is struck daily whether or not anyone redeems.

Why: Open-end funds compute NAV once per business day, after the market closes (forward pricing).

Silvestra uses the exchange privilege to move 25,000 dollars from Ravelston Short Term Bond Fund into Ravelston Growth Fund, both in the same family, at net asset value. She is surprised to receive paperwork covering two transactions rather than one. Her representative should explain that:

1. A.The fund made an error and should have processed a single transfer of shares between the two portfolios.No error occurred. An exchange is always processed as a redemption followed by a purchase.
2. B.An exchange is processed as a redemption of the first fund and a purchase of the second, and in a taxable account the redemption leg is a reportable sale.Correct. The exchange privilege waives the sales charge but the transaction is still a redemption plus a purchase, and it is taxable.
3. C.The second document is a duplicate confirmation sent to her tax preparer as a courtesy.Both documents reflect the two legs of her own transaction, not a duplicate sent elsewhere.
4. D.Because no sales charge applied, the transaction is not reportable for tax purposes.The sales charge waiver has no bearing on taxation. The redemption leg produces gain or loss.

Why: An exchange is processed as a redemption of the first fund followed by a purchase of the second, so the confirmation reflects both legs. The exchange privilege waives a new sales charge within the family, but it does not change the mechanics: shares of the first fund are cancelled and shares of the second are issued, and in a taxable account the redemption leg is a reportable sale.