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Behavioral Finance

This overview explores the historic forms of mutual funds, focusing on the distinctions between open-end and closed-end funds. Open-end funds allow investors to purchase units that represent actual securities, which are traded at their net asset value (NAV). In contrast, closed-end funds involve an IPO and have a fixed number of shares, leading to potential discrepancies between market price and underlying asset values. Additionally, Exchange-Traded Funds (ETFs) are introduced as a hybrid that allows for the creation and destruction of shares, enabling arbitrage opportunities.

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Historic Forms of Mutual Funds • Open End Funds • Closed End Funds

  3. Open End Funds are the Typical • An investors sends cash to the mutual fund to buy a unit interest in the fund • The fund takes the investor’s cash and buys securities in exactly the same proportions as exist in the current fund • When an investor sells his unit interest, the fund liquidates shares in the funds to redeem the investor’s interest

  4. Closed End Funds • They begin by purchasing securities • Then they do an IPO to the public selling shares in the fund • After that, the fund shares are fixed in number and the shares trade in the open market

  5. Problem • No problem with open end fund. The investor buys and sells at NAV (net asset value) • Problem arises with closed end fund • Price of a share can diverge from the stock values in the fund • Begin at a premium and, over time, trade at a discount • Discount only goes away when fund is terminated

  6. ETFs (Exchange Traded Funds) • Created much like closed end funds: securities pooled together to create a fund • Then shares in the pool sold to the public • But (“creation units”) • Shares can be created • Shares can be destroyed • Permits arbitrage to solve the closed end puzzle

  7. The End

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