Pension, Mutual, and Hedge Funds

pension funds

offer savings plan through which fund participants accumulate tax-deferred savings during their working years before withdrawing them in their retirement years

defined benefit pension fund

fund in which employer agrees to pay employees a specific cash benefit in retirement

flat benefit formula

flat amount * number of years employed

career average formula

percentage of the average salary during the entire period * the number of years employed

final pay formula

percentage of the average salary during a specified number of years at the end of the career * years employed

fully funded pension fund

has sufficient funds available to meet all future promised obligations

underfunded pension fund

doesn’t have sufficient funds available to meet all future promised payments

overfunded pension fund

has more than enough funds

defined contribution fund

fund in which the employer agrees to make a specified contribution to the pension fund during the employee’s working years

main asset item for pension funds

corporate equities

insured pension funds

administered by life insurance companies

noninsured pension funds

managed by a trustee

private pension funds

created by private entities and are administered by private companies (financial institutions)

public pension funds

sponsored and administered by the federal, state, or local governments

401(k)

employer sponsored plan that supplements a firm’s basic retirement plan (allows for both employee and employer contributions)

• private / for-profit companies

403(b)

employer sponsored plan that supplements a firm’s basic retirement plan (allows for both employee and employer contributions)

• nonprofit organizations (hospitals, etc)

keogh accounts

retirement accounts designed for unincorporated businesses or self-employed individuals

individual retirement accounts (IRAs)

self-directed retirement accounts set up by employers who may also be covered by employer-sponsored plans as well as self-employed individuals

• contributions made only by employee

FICA tax (7.65%) - social security

social security tax (6.2%) + medicare tax (1.45%)

• employer matches these percentages to total 15.3%

employee retirement security act (ERISA) of 1974

put the department of labor in charge of overseeing the pension funds

ERISA areas of reform (5)

1. funding

2. transferability

3. vesting of benefits

4. fiduciary responsibility

5. pension fund insurance

mutual funds

investment company made up of a pool of money, collected from many investors to invest in various securities

short-term funds (MMMFs)

original maturities <= 1 year

1. government money funds

2. municipal (tax-exempt) money funds

3. prime (general purpose) money funds

government money funds

invest at least 99.5% of the fund’s total assets in cash, government securities, and/or repos that are fully collateralized by cash or government securities

municipal (tax-exempt) money funds

invest in municipal securities whose interest is exempt from federal income tax

prime (general purpose) money funds

invest in any money market instruments, including commercial paper, CDs, and other private instruments

long-term funds

original maturities > 1 year

1. equity funds

2. bonds funds

3. hybrid funds

equity funds

consist of common and preferred stock

bonds funds

consist of long-term fixed-income securities

hybrid funds

consist of both stock and bond securities

sales loads

one-time commission charge at the point of sale

fund operating expenses

fees charged to cover fund-level expenses, calculated as an annualized percentage of the net assets invested

management fees

typically the largest fee charged to mutual fund owners

distribution expenses (12b-1 fee)

paid for marketing/selling fund shares

shareholder servicing costs (12b-1 fee)

paid to persons to respond to investor inquires

index funds

funds in which managers buy securities in proportions similar to those included in a specified major stock index

net asset value (NAV)

represents the per-share market value of a mutual fund, etf, or reit; enables investors to understand the current value of their holdings and is typically calculated at market close

money market mutual funds (MMMFs)

cash-like funds whose NAVs normally stay constant at $1

Lehman Brother’s

“broke the buck”

investment company

company that pools funds from individual investors and invests them

• all mutual funds are investment companies but not all investment companies are mutual funds

open-end funds

funds sell shares to anyone wishing to buy and redeem shares from anyone wishing to sell (at NAV)

• all mutual funds are this

closed-end funds

the number of shares is fixed and never changes; if you want to buy/sell shares, you must trade with other investors

• REITS

regulator of mutual funds

SEC; heavily regulated because they invest the savings of the average american

hedge funds

viewed as a special type of mutual fund

long-term capital management (LTCM)

hedge fund run by John Meriwether; found securities that were misspriced and took long positions on the cheap ones and short positions on the expensive ones