MGT604 - Management of Financial Institutions - Lecture Handout 26

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Mutual Funds

Navigating the Investing Frontier: Where the Frauds Are

Many fraudsters rely on the telephone to carry out their investment scams. Using a technique known as cold calling (so-called because a caller telephones a person with whom they have not had previous contact), these fraudsters will hound you to buy stocks in small, unknown companies that are highly risky or, sometimes, part of a scam. In recent years, the Internet has also become increasingly attractive to fraudsters because it allows an individual or company to communicate with a large audience without spending a lot of time, effort, or money.

You should be skeptical of any offers you learn about from a cold caller or through the Internet. Here's what you need to know about cold calling and Internet fraud.

Cold calling

For many businesses, including securities firms, cold calling serve as a legitimate way to reach potential customers. Honest brokers use cold calling to find clients for the long term. They ask questions to understand your financial situation and investment goals before recommending that you buy anything.

Dishonest brokers use cold calling to find "quick hits." Some set up "boiler rooms" where high-pressure salespeople use banks of telephones to call as many potential investors as possible. Aggressive cold callers speak from persuasive scripts that include retorts for your every objection. As long as you stay on the phone, they'll keep trying to sell. And they won't
let you get a word in edgewise. Our advice is to avoid making any direct investments over the phone.

Internet Fraud

The Internet serves as an excellent tool for investors, allowing them to easily and inexpensively research investment opportunities. But the Internet is also an excellent tool for fraudsters. That's why you should always think twice before you invest your money in any opportunity

you learn about through the Internet Anyone can reach tens of thousands of people by building an Internet Web site, posting a message on an online message board, entering a discussion in a live "chat" room, or sending mass e-mails. It's easy for fraudsters to make their messages look real and credible. But it's nearly impossible for investors to tell the
difference between fact and fiction.

Types of Investment Fraud

The types of investment fraud seen online mirror the frauds perpetrated over the phone or through the mail. Here are the most common investment schemes and the "red flags" you should watch for:

• The "PUMP and DUMP" rip-off

It's common to see messages posted on the Internet that urge readers to buy a stock quickly or to sell before the price goes down. Cold callers often call using the same sort of pitch. Often the promoters will claim to have "inside" nformation about an impending development or an "infallible" combination of economic and stock market data to pick stocks. In reality, they may be insiders or paid promoters who stand to gain by selling their shares after the stock price is pumped up by gullible investors. Once these fraudsters sell their shares and stop hyping the stock, the price typically falls and investors lose their money. Fraudsters frequently use this ploy with small, thinly traded companies because it's easier to manipulate a stock when there's little or no information available about the company.

• The Pyramid Scheme

In the classic "pyramid" scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of skyhigh returns in a short period of time for doing nothing other than handing over your money and getting others to do the same. Money coming in from new recruits is used to pay off early stage investors. But eventually the pyramid will collapse. At some point, the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money. Table 1 shows how pyramid schemes can become impossible to sustain.

How to Avoid Investment Fraud

To invest wisely and avoid investment scams, research each investment opportunity thoroughly and ask questions. Get the facts before you invest, and only invest money you can afford to lose. You can avoid investment scams by asking-and getting answers to-these three simple questions:

1. Is the investment registered?

Many investment scams involve unregistered securities. So you should always find out whether the company has registered its securities with the SEC or your state securities regulators. You can do this by checking the SECP's website database or by calling SECP. Some smaller companies don't have to register their securities offerings with the SEC, so
always make background check and ask for referrals etc.

2. Is the person licensed and law-abiding?

Try and find out whether the person or firm selling the investment is properly licensed and whether they've had run-ins with regulators or received serious complaints from investors. This information may be difficult to get in Pakistan.

3. does the investment sound too good to be true?

If it does, it probably is. High-yield investments tend to involve extremely high risk. Never invest in an opportunity that promises "guaranteed" or "risk-free" returns. Watch out for claims of astronomical yields in a short period of time. Be skeptical of "offshore" or foreign investments. And beware of exotic or unusual sounding investments. Make sure you fully understand the investment before you part with your hard-earned money. Always ask for and carefully read-the company's prospectus. You should also read the most recent reports the company has filed with its regulators and pay attention to the company's financial statements, particularly if they do not say they have been audited or certified by an
accountant.

Mutual Funds - The Logic behind Investing in Them

Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. This article helps you to know in depth on:

  • Is it possible to diversify investment if invested in mutual funds?
  • Find more on the working of mutual fund
  • Know more about the legal aspects in relation to the mutual funds

At the beginning of this millennium, mutual funds out numbered all the listed securities in New York Stock Exchange. Mutual funds have an upper hand in terms of diversity and liquidity at lower cost in comparison to bonds and stocks. The popularity of mutual funds may be relatively new but not their origin which dates back to 18th century. Holland saw the origination of mutual funds in 1774 as investment trusts before spreading to Anglo- Saxon countries in its current form by 1868. We will discuss now as to what are mutual funds before going on to seeing the advantages of mutual funds. Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. The stocks these mutual funds have are very fluid and are used for buying or redeeming and/or selling shares at a net asset value. Mutual funds posses shares of several companies and receive dividends in lieu of them and the earnings are distributed among the share holders.

Are Mutual Funds Risk Free and what are the Advantages?

One must not forget the fundamentals of investment that no investment is insulated from risk. Then it becomes interesting to answer why mutual funds are so popular. To begin with, we can say mutual funds are relatively risk free in the way they invest and manage the funds. The investment from the pool is well diversified across securities and shares from various sectors. The fundamental understanding behind this is not all corporations and sectors fail to perform at a time. And in the event of a security of a corporation or a whole sector doing badly then the possible losses from that would be balanced by the returns from other shares. This logic has seen the mutual funds to be perceived as risk free investments
in the market. Yes, this is not entirely untrue if one takes a look at performances of various mutual funds. This relative freedom from risk is in addition to a couple of advantages mutual funds carry with them. So, if you are a retail investor and planning an investment in securities, you will certainly want to consider the advantages of investing in mutual funds.

  • Lowest per unit investment in almost all the cases
  • Your investment will be diversified
  • Your investment will be managed by professional money managers.

There is no one method of classifying mutual funds risk free or advantageous. However we can do the same by way of classifying mutual funds as per their functioning and the type of funds they offer to investors. This Course makes you aware on:

  • What are the reasons that make the close ended mutual finds more attractive?
  • What are the factors that determine the prices of exchange traded funds?
  • Find out the features of open ended mutual funds