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IFMP Mutual Fund Basic Certification (MFBC), Pakistan study materials
IFMP Mutual Fund Basic Certification (MFBC), Pakistan study resources

IFMP Mutual Fund Basic Certification (MFBC), Pakistan practice questions

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Question 1Mutual Fund Basics

Under SECP regulation in Pakistan, a mutual fund pools money from many investors and invests it primarily in which of the following?

  1. A diversified portfolio of securities such as shares, bonds and money market instruments Correct answer.
  2. Physical commodities held in a central depository
  3. A single company's shares chosen by each investor individually
  4. Direct real estate titles registered to each investor

Explanation

A mutual fund is a collective investment scheme that pools investor money and deploys it into a diversified portfolio of securities managed by a professional asset manager. Individual investors own units of the pool rather than direct title to each underlying asset.

Question 2Mutual Fund Basics

An investor buys units of an open-end mutual fund. What does each unit represent?

  1. A proportionate share of the fund's net assets Correct answer.
  2. A secured claim on the fund's bank account
  3. A guaranteed minimum return promised by the trustee
  4. A fixed-interest loan to the asset management company

Explanation

Units are the investor's proportionate ownership interest in the pooled net assets of the scheme. As the fund's net asset value changes, the value of each unit changes accordingly. Units are not debt instruments and carry no guaranteed return.

Question 3Mutual Fund Basics

How is the net asset value (NAV) per unit of a mutual fund calculated?

  1. Market price of the largest holding divided by units
  2. Net assets of the fund divided by units outstanding Correct answer.
  3. Total assets divided by the number of investors
  4. Total units outstanding divided by total expenses

Explanation

NAV per unit equals the fund's total assets minus its liabilities, divided by the number of units outstanding. It reflects the per-unit value of the underlying portfolio on the valuation date.

Question 4Mutual Fund Basics

Which party to a mutual fund holds the fund's assets in custody and acts in the interest of unit holders?

  1. The investment adviser
  2. The trustee or custodian Correct answer.
  3. The distributor
  4. The selling agent

Explanation

The trustee or custodian safeguards fund assets and oversees compliance in the interest of unit holders, separate from the manager. This separation protects investors from misuse of fund property.

Question 5Mutual Fund Basics

In an open-end mutual fund, how do investors typically exit their investment?

  1. By waiting until the fund's fixed maturity date
  2. By selling units only to another investor on a stock exchange
  3. By converting units into secured debentures of the manager
  4. By selling units back to the fund at the applicable NAV Correct answer.

Explanation

Open-end funds continuously redeem units at the prevailing NAV, so investors exit by redeeming with the fund. Exchange trading is characteristic of closed-end funds, which are not continuously redeemed.

Question 6Mutual Fund Basics

Which of the following best describes a closed-end mutual fund?

  1. A fund that guarantees redemption at NAV on any business day
  2. A fund that issues a fixed number of units listed and traded on a stock exchange Correct answer.
  3. A fund whose unit count changes daily with new subscriptions and redemptions
  4. A fund that invests only in government treasury bills

Explanation

A closed-end fund raises a fixed pool at launch, and its units trade on an exchange at market prices that may differ from NAV. It does not continuously issue or redeem units.

Question 7Mutual Fund Basics

A fund that invests mainly in short-term money market instruments with the aim of preserving capital and providing liquidity is called what?

  1. A money market fund Correct answer.
  2. An aggressive growth fund
  3. A sector fund
  4. An equity fund

Explanation

Money market funds hold short-term, low-risk instruments such as treasury bills and deposits to provide liquidity and stability of principal. Equity and sector funds carry higher market risk.

Question 8Mutual Fund Basics

What is the primary role of the asset management company (AMC) in a mutual fund structure?

  1. To manage the investment portfolio and operate the scheme Correct answer.
  2. To audit the fund's annual accounts
  3. To set the regulatory framework for the industry
  4. To hold the fund's securities in safekeeping

Explanation

The AMC manages the scheme's investments, makes buy and sell decisions and runs day-to-day operations under the trust deed and regulations. Custody, audit and regulation rest with separate parties.

Question 9Mutual Fund Basics

A fund's gross assets are Rs 520 million and its liabilities are Rs 20 million. It has 50 million units outstanding. What is the NAV per unit?

  1. Rs 9.60
  2. Rs 10.40
  3. Rs 10.00 Correct answer.
  4. Rs 10.80

Explanation

NAV per unit = (assets minus liabilities) divided by units = (520 - 20) / 50 = 500 / 50 = Rs 10.00. Liabilities must be deducted before dividing by units outstanding.

Question 10Mutual Fund Basics

A fund charges a front-end load of 2 percent. An investor invests Rs 100,000. Assuming the load is deducted from the investment amount, how much is actually used to buy units?

  1. Rs 96,000
  2. Rs 98,000 Correct answer.
  3. Rs 100,000
  4. Rs 102,000

Explanation

A front-end load is charged at the time of investment, so 2 percent of Rs 100,000 (Rs 2,000) is deducted, leaving Rs 98,000 to purchase units. The load is a sales charge, not an addition to the investment.

Question 11Mutual Fund Basics

Which of the following is a recurring cost that reduces a fund's NAV over time?

  1. The management fee charged by the AMC Correct answer.
  2. The bid-offer spread on exchange trades
  3. The capital gains tax paid by an exiting investor
  4. The front-end load paid by new investors

Explanation

The management fee is a recurring expense charged to the fund and reflected in the NAV, so it reduces returns over time. Loads are one-time charges to the investor, and taxes on an investor's gains are not fund expenses.

Question 12Mutual Fund Basics

What does the expense ratio of a mutual fund measure?

  1. The total return earned by the fund in a year
  2. The annual operating expenses of the fund as a percentage of its average net assets Correct answer.
  3. The percentage of units held by the largest investor
  4. The difference between the fund's NAV and its market price

Explanation

The expense ratio expresses annual operating costs, including management and administrative fees, as a percentage of average net assets. It is a cost measure, not a return or ownership measure.

Question 13Mutual Fund Basics

An investor compares two equity funds with similar portfolios; Fund A has an expense ratio of 1.0 percent and Fund B of 2.0 percent. All else equal, what is the likely effect over the long run?

  1. Fund B will always outperform because it charges more for research
  2. Fund B will tend to deliver higher net returns because higher fees signal better management
  3. Fund A will tend to deliver higher net returns because lower costs leave more of the gross return Correct answer.
  4. Both funds will deliver identical net returns because expenses are deducted before gross return

Explanation

Because expenses are deducted from gross returns, a lower expense ratio leaves more of the portfolio return with investors, all else equal. Higher fees do not by themselves improve performance.

Question 14Mutual Fund Basics

A fund's NAV per unit rises from Rs 50 to Rs 55 over one year, and it pays a distribution of Rs 2 per unit during the year. What is the investor's total return for the year?

  1. 12 percent
  2. 4 percent
  3. 14 percent Correct answer.
  4. 10 percent

Explanation

Total return combines the NAV change (Rs 5) and the distribution (Rs 2), giving Rs 7 on a starting NAV of Rs 50, or 14 percent. Distributions must be included, not just price change.

Question 15Mutual Fund Basics

What is the purpose of a fund's offering document (prospectus)?

  1. To guarantee a minimum annual return to unit holders
  2. To disclose the fund's objectives, risks, charges and policies to prospective investors Correct answer.
  3. To appoint the trustee and auditor of the fund
  4. To record the daily trading activity of the fund's portfolio

Explanation

The offering document discloses the investment objective, strategy, risks, fees and operational details so investors can make an informed decision. It is a disclosure document, not a guarantee or trading record.

Question 16Mutual Fund Basics

A fund's investment policy states that it may invest up to 10 percent of net assets in a single security. Why does such a limit matter to investors?

  1. It ensures the fund trades above its NAV
  2. It limits concentration risk from any one issuer Correct answer.
  3. It fixes the fund's expense ratio
  4. It guarantees that the fund will not lose money

Explanation

Concentration limits spread exposure across issuers, reducing the impact of a single security's failure on the portfolio. Such limits manage risk but do not guarantee against loss or fix costs.

Question 17Mutual Fund Basics

Which risk is most directly reduced by holding a diversified portfolio within an equity mutual fund?

  1. Inflation risk affecting all assets
  2. Company-specific (unsystematic) risk Correct answer.
  3. Currency risk of the fund's base currency
  4. Market (systematic) risk

Explanation

Diversification across many issuers reduces company-specific risk because poor performance of one holding is offset by others. Market, inflation and currency risks affect the whole portfolio and are not removed by diversification.

Question 18Mutual Fund Basics

An investor wants regular periodic income rather than capital appreciation. Which fund type is most suitable?

  1. An income fund investing in fixed-income securities Correct answer.
  2. A sector fund focused on technology shares
  3. A money market fund held for daily liquidity only
  4. An aggressive equity growth fund

Explanation

Income funds invest in fixed-income securities that generate periodic coupon income, which can be distributed to unit holders. Growth and sector funds focus on capital appreciation, and a pure liquidity fund is not designed for regular income.

Question 19Mutual Fund Basics

What is the cut-off time in mutual fund subscriptions primarily used to determine?

  1. The maximum number of units an investor may buy
  2. Which day's NAV applies to a subscription or redemption request Correct answer.
  3. The fund's annual expense ratio
  4. The sales load charged to the investor

Explanation

Requests received before the cut-off time are processed at that day's NAV, while later requests use the next applicable NAV. This ensures fair treatment of all investors in pricing transactions.

Question 20Mutual Fund Basics

An investor redeems units of an equity fund within 30 days of purchase, and the fund applies a contingent load on early exits. What is the main purpose of this charge?

  1. To increase the fund's NAV for remaining investors
  2. To compensate the trustee for custody services
  3. To pay the auditor's annual fees
  4. To discourage short-term trading that harms long-term unit holders Correct answer.

Explanation

A contingent or exit load discourages frequent short-term trading that forces the fund to trade its portfolio and raises costs for long-term investors. The charge protects remaining unit holders from the cost of rapid inflows and outflows.

Question 21Mutual Fund Basics

A closed-end fund's units trade on an exchange at Rs 9.20 while its NAV per unit is Rs 10.00. How is this situation described?

  1. The fund has a negative expense ratio
  2. The fund is trading at a premium of 8 percent
  3. The fund is trading at a discount of 8 percent Correct answer.
  4. The fund is trading at par

Explanation

When the market price is below NAV, the fund trades at a discount, calculated as (10.00 - 9.20) / 10.00 = 8 percent. A premium occurs when the price exceeds NAV, and trading at par means price equals NAV.

Question 22Mutual Fund Basics

A fund's gross return for the year is 12 percent and its expense ratio is 1.5 percent. Ignoring other charges, what is the approximate net return to unit holders?

  1. 9.0 percent
  2. 12.0 percent
  3. 10.5 percent Correct answer.
  4. 13.5 percent

Explanation

Expenses are deducted from gross return, so 12 percent minus 1.5 percent gives approximately 10.5 percent net. The expense ratio reduces, rather than adds to, the return earned by investors.

Question 23Mutual Fund Basics

An investor is comparing a fund's disclosed expense ratio with its actual performance. Which statement is most accurate?

  1. The expense ratio is charged only when units are redeemed
  2. The expense ratio must be added to reported NAV returns to get the true return
  3. The expense ratio is already reflected in the NAV, so reported returns are net of ongoing costs Correct answer.
  4. The expense ratio applies only to new investors and not to existing unit holders

Explanation

Ongoing fund expenses are deducted in arriving at NAV, so published NAV-based returns are already net of these costs. Investors do not add the expense ratio back, and it applies to all unit holders continuously.

Question 24Mutual Fund Basics

A trustee of a mutual fund notices that the AMC has deviated from the investment limits in the offering document. What is the trustee's appropriate course of action?

  1. Ignore the deviation because the AMC is responsible for investment decisions
  2. Report the breach to the regulator and require corrective action Correct answer.
  3. Sell the fund's units to recover losses for investors
  4. Adjust the NAV to hide the effect of the breach

Explanation

The trustee oversees compliance with the trust deed and regulations and must report breaches to the regulator and seek correction. The trustee's oversight role exists precisely to protect unit holders from such deviations.

Question 25Mutual Fund Basics

Which statement correctly distinguishes a mutual fund from a bank deposit?

  1. Both provide identical capital protection under regulation
  2. A mutual fund's value fluctuates with its portfolio while a bank deposit carries a stated interest rate Correct answer.
  3. A mutual fund is insured against loss while a bank deposit is not
  4. A mutual fund offers a fixed return while a bank deposit carries market risk

Explanation

Mutual fund returns depend on the performance of the underlying portfolio and are not fixed, whereas a bank deposit earns a stated interest rate. Mutual fund investments are not guaranteed or insured against market loss.

Question 26Mutual Fund Basics

In a mutual fund structure, which party holds the fund's assets in custody on behalf of the unit holders?

  1. The selling agent
  2. The trustee or custodian Correct answer.
  3. The distributor network
  4. The asset management company

Explanation

The trustee or custodian is legally separate from the AMC and holds the fund's assets in safe custody for the benefit of unit holders. The AMC manages the portfolio but does not itself hold investor assets, which is a core investor-protection safeguard in the mutual fund structure.

Question 27Mutual Fund Basics

Which document sets out a mutual fund's investment objectives, authorised investments, and the limits within which the manager must operate?

  1. The annual audited accounts
  2. The distributor agreement
  3. The offering document together with the constitutive documents Correct answer.
  4. The trust deed

Explanation

The offering document, read with the constitutive documents such as the trust deed, defines the fund's objectives, permitted investments and limits, and the manager must operate within them. Audited accounts report on past performance rather than authorising future investment activity.

Question 28Mutual Fund Basics

A mutual fund's units are continuously issued and redeemed at NAV-based prices calculated after each dealing cut-off. This describes which fund structure?

  1. A closed-end fund
  2. An open-end fund Correct answer.
  3. A listed exchange-traded fund trading at market price
  4. A unit investment trust with a fixed term

Explanation

An open-end fund stands ready to issue new units and redeem existing units at prices derived from the NAV struck after each cut-off. The number of units therefore changes with investor flows rather than being fixed at launch.

Question 29Mutual Fund Basics

Which term describes the price at which an open-end fund's units are redeemed, calculated by dividing net assets by the number of units outstanding?

  1. The offer price including all future loads
  2. The redemption price based on NAV Correct answer.
  3. The market price
  4. The par value

Explanation

Redemption proceeds are based on NAV per unit, which equals net assets divided by units outstanding, adjusted for any applicable redemption charge. The NAV is the fundamental valuation benchmark for open-end fund dealings.

Question 30Mutual Fund Basics

Which of the following best describes the role of a mutual fund's auditor?

  1. To independently verify the financial statements and NAV calculations Correct answer.
  2. To approve each individual trade before execution
  3. To set the fund's investment strategy
  4. To market the fund to prospective investors

Explanation

The auditor provides independent assurance that the fund's financial statements and NAV determinations are fairly stated. This independent check supports investor confidence in the prices at which units are issued and redeemed.

Question 31Mutual Fund Basics

A fund's net assets are Rs 840 million and it has 60 million units outstanding. What is the NAV per unit?

  1. Rs 12.00
  2. Rs 18.00
  3. Rs 14.00 Correct answer.
  4. Rs 16.00

Explanation

NAV per unit equals net assets divided by units outstanding, so Rs 840 million divided by 60 million units gives Rs 14.00 per unit. This figure is the basis for both issuance and redemption prices before any sales or redemption charges.

Question 32Mutual Fund Basics

Which of the following investors is most likely to prefer a money market fund over an equity fund?

  1. An investor willing to accept large short-term price swings for higher returns
  2. An investor seeking maximum long-term capital growth
  3. An investor seeking exposure to a concentrated sector bet
  4. An investor who needs a temporary home for cash with high liquidity and low volatility Correct answer.

Explanation

Money market funds invest in short-term, high-quality instruments and aim to preserve capital while offering ready liquidity. They suit investors parking cash temporarily rather than those pursuing growth or accepting volatility.

Question 33Mutual Fund Basics

Which statement best explains why a mutual fund must publish its NAV daily?

  1. To guarantee that the fund will not fall below its launch price
  2. To allow the regulator to set the fund's fees
  3. To determine the tax payable by the AMC
  4. To give investors a transparent basis for dealing and monitoring their holdings Correct answer.

Explanation

Daily NAV publication provides a transparent, verifiable price at which units are bought and sold and lets investors track the value of their holdings. Transparency in pricing is a central investor-protection feature of collective investment schemes.

Question 34Mutual Fund Basics

An investor places a purchase order for a fund that charges a 3 percent front-end load and invests Rs 200,000. If the load is deducted from the investment amount, how much is actually invested in the fund?

  1. Rs 194,000 Correct answer.
  2. Rs 197,000
  3. Rs 206,000
  4. Rs 200,000

Explanation

A 3 percent front-end load on Rs 200,000 is Rs 6,000, so Rs 194,000 is invested and the balance is retained as the sales charge. The load reduces the amount that actually buys units, which is why it matters to compare net invested amounts across funds.

Question 35Mutual Fund Basics

A fund's NAV per unit is Rs 25.00 and it declares a distribution of Rs 1.50 per unit. Immediately after the distribution, all else equal, what happens to NAV per unit?

  1. It remains at Rs 25.00
  2. It falls to Rs 25.00 only if units are redeemed
  3. It falls to about Rs 23.50 Correct answer.
  4. It rises to Rs 26.50

Explanation

A distribution is paid out of the fund's assets, so net assets and therefore NAV per unit fall by the distribution amount, giving about Rs 23.50. Investors receive the distribution in cash or as reinvested units, so their total value is broadly unchanged apart from tax.

Question 36Mutual Fund Basics

Which of the following best describes the difference between a fund's 'distribution' and its 'total return'?

  1. Distribution measures income paid out, while total return combines NAV change and distributions Correct answer.
  2. Total return ignores changes in NAV
  3. Distribution is always larger than total return
  4. Distribution and total return are identical measures

Explanation

Distribution refers to income or gains actually paid to unit holders, whereas total return captures both the change in NAV and any distributions over the period. A fund may pay little or no distribution yet deliver a strong total return through NAV growth.

Question 37Mutual Fund Basics

A fund's investment policy limits exposure to a single sector to 30 percent of net assets. Which purpose does such a limit primarily serve?

  1. It ensures the fund always outperforms its benchmark
  2. It removes the need for diversification across securities
  3. It guarantees a minimum return for investors
  4. It constrains concentration risk and keeps the fund within its stated risk profile Correct answer.

Explanation

Sector limits prevent the portfolio from becoming overly dependent on one part of the market and keep the fund's risk consistent with what investors were promised. They are a risk-control device, not a performance guarantee.

Question 38Mutual Fund Basics

Which risk is most directly reduced when a bond fund holds securities with a range of maturities rather than concentrating in long-dated bonds?

  1. Credit risk of the issuers
  2. Operational risk
  3. Interest rate risk Correct answer.
  4. Currency risk

Explanation

Spreading maturities across the yield curve reduces sensitivity to a single move in interest rates, which is interest rate risk. Credit risk relates to issuer default and is addressed by credit quality limits rather than by maturity spread.

Question 39Mutual Fund Basics

An investor wants to invest a lump sum but is unsure about market timing. Which feature of a mutual fund most directly allows gradual entry over time?

  1. A dividend reinvestment option
  2. A fund-of-funds structure
  3. A contingent deferred sales charge
  4. A systematic investment plan Correct answer.

Explanation

A systematic investment plan lets an investor contribute fixed amounts at regular intervals, averaging the entry price over time. This reduces the impact of any single purchase being made at an unfavourable market level.

Question 40Mutual Fund Basics

A fund's gross assets are Rs 1,200 million, its liabilities are Rs 150 million, and it has 70 million units. What is the NAV per unit?

  1. Rs 19.29
  2. Rs 18.00
  3. Rs 15.00 Correct answer.
  4. Rs 17.14

Explanation

Net assets equal gross assets minus liabilities, giving Rs 1,050 million, and dividing by 70 million units yields Rs 15.00 per unit. Using gross assets without deducting liabilities would overstate the NAV.

Question 41Mutual Fund Basics

Which statement best explains why a fund's expense ratio is disclosed as a percentage of average net assets?

  1. It replaces the need to disclose individual expense items
  2. It guarantees that expenses will not rise in future
  3. It fixes the fee in rupees regardless of fund size
  4. It allows costs to be compared across funds of different sizes Correct answer.

Explanation

Expressing costs as a percentage of average net assets normalises them, so a large and a small fund can be compared on the same basis. It also shows investors the annual drag on returns attributable to running the fund.

Question 42Mutual Fund Basics

An investor holds units in an equity fund and the benchmark index falls 15 percent while the fund falls 12 percent. What does this most likely indicate?

  1. The fund has outperformed its benchmark on a relative basis Correct answer.
  2. The fund must have increased its cash holdings to 100 percent
  3. The fund's NAV is unaffected by market movements
  4. The fund has guaranteed capital protection

Explanation

A smaller decline than the benchmark means the fund outperformed on a relative basis over that period, though it still lost value in absolute terms. Relative performance is assessed against a comparable benchmark, not by absolute gain alone.

Question 43Mutual Fund Basics

Which of the following best describes the purpose of a fund's benchmark in performance reporting?

  1. It guarantees the fund will match market returns
  2. It provides a reference against which the fund's returns and risk can be judged Correct answer.
  3. It sets the maximum fee the fund may charge
  4. It determines the fund's tax treatment

Explanation

A benchmark gives investors a relevant yardstick for judging whether the manager's returns justify the fees and risk taken. Comparisons are meaningful only where the benchmark matches the fund's mandate and asset class.

Question 44Mutual Fund Basics

An investor compares two funds: Fund X has a NAV of Rs 10 and Fund Y has a NAV of Rs 100. Both invest in similar portfolios. Which conclusion is most defensible?

  1. Fund X must have lower expenses because its NAV is lower
  2. Fund Y is ten times more valuable per unit and therefore a better fund
  3. NAV per unit alone says nothing about which fund is the better investment Correct answer.
  4. Fund Y must have higher risk because its NAV is higher

Explanation

NAV per unit reflects the size of the unit, not the quality or return of the fund, so it cannot be used to rank funds. Comparison should be based on returns, risk, costs and mandate, not on the absolute NAV figure.

Question 45Mutual Fund Basics

A fund's offering document states that it may borrow up to 15 percent of net assets for temporary liquidity. Which statement best explains why such borrowing is restricted?

  1. Borrowing magnifies losses and can expose unit holders to risks beyond the fund's stated profile Correct answer.
  2. Borrowing reduces the fund's ability to meet redemptions
  3. Borrowing increases the fund's expense ratio to an unlimited extent
  4. Borrowing is prohibited for all collective investment schemes

Explanation

Leverage magnifies both gains and losses, so limits on borrowing keep risk within the level investors were promised. Temporary borrowing for redemptions is permitted within caps precisely because it is meant to be short-term and modest.

Question 46Mutual Fund Basics

A fund's value rises from Rs 80 to Rs 88 per unit over a year and it pays a distribution of Rs 4 per unit. What is the total return for the year?

  1. 20 percent
  2. 15 percent Correct answer.
  3. 10 percent
  4. 5 percent

Explanation

Total return combines NAV appreciation of Rs 8 with the Rs 4 distribution, giving Rs 12 on a starting NAV of Rs 80, which is 15 percent. Ignoring the distribution understates the investor's actual return.

Question 47Mutual Fund Basics

An investor in a fund with a 1.8 percent expense ratio and a 2 percent front-end load compares it with a no-load fund with a 0.9 percent expense ratio. Over a long holding period, which cost difference dominates?

  1. The front-end load, because it is paid first
  2. The load, because it is always larger in rupees
  3. Neither, because both are deducted from the AMC's own profits
  4. The expense ratio, because it is charged every year on net assets Correct answer.

Explanation

A recurring expense ratio compounds against the investor every year, so over a long horizon its cumulative impact typically exceeds a one-time front-end load. Cost comparison should therefore weigh recurring charges heavily for long-term holdings.

Question 48Mutual Fund Basics

A trustee observes that the AMC has breached a stated investment limit but the fund has not yet reported it. What is the trustee's most appropriate course of action?

  1. Sell the fund's units personally to limit losses
  2. Require the AMC to rectify the breach and report it to the regulator as required Correct answer.
  3. Wait for the next annual audit to raise the matter
  4. Adjust the NAV to remove the effect of the breach

Explanation

The trustee is responsible for safeguarding unit holders' interests and must require prompt rectification and reporting of breaches to the regulator. Delaying until the audit would allow the breach and any harm to continue.

Question 49Mutual Fund Basics

Which combination most clearly distinguishes a mutual fund investment from a bank deposit?

  1. Deposits are market-linked while mutual funds are guaranteed
  2. Market-linked returns with no deposit insurance, versus fixed or contracted returns with deposit protection Correct answer.
  3. A mutual fund guarantees a fixed return while a deposit does not
  4. Both offer identical capital protection but differ in name only

Explanation

Mutual fund returns are market-linked and units can fall in value, and fund investments are not covered by deposit insurance. Bank deposits offer contracted returns and may be protected by a deposit insurance scheme up to a limit.

Question 50Mutual Fund Basics

A fund's NAV per unit is Rs 50 and it has 40 million units. The manager expects redemptions of 10 percent of units next week and holds 5 percent of net assets in cash. Which statement best describes the liquidity implication?

  1. Redemptions have no effect on the fund's portfolio because units are simply cancelled
  2. The fund must suspend redemptions whenever cash is below 10 percent
  3. The fund may need to sell assets to meet redemptions, which can create transaction costs for remaining investors Correct answer.
  4. The fund can meet redemptions from cash alone without selling any assets

Explanation

Redemptions of 10 percent of units exceed the 5 percent cash buffer, so assets must be sold, and the resulting transaction costs and price impact are borne by the fund. Managing liquidity is therefore a core portfolio function in open-end funds.