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Open-end mutual fund redemptions (part 2) | Finance & Capital Markets | Khan Academy - YouTube
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Let's continue with the
story of Pete's mutual fund.
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So let's say that a year goes by
and that even after paying Pete
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the 1%, so it had $500 of
assets under management,
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this whole assets under
management a year later,
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let's say it goes
to, like I mentioned
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at the end of the
last video, $1,000.
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So Pete either is really
good at or really lucky,
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or a little bit of both.
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So it goes to $1,000.
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So let me draw it like this.
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So now it is that
$1,000, and it still
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has the same five
investors here.
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And I'm lucky enough
to be one of them.
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So here are the five investors.
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Let me draw the shares.
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So there's one, two,
three, four, five shares.
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Now, each of the
shares-- well, the $1,000
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is called the NAV, or
the net asset value.
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So let me give you that
piece of terminology,
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just means net asset value.
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And so there's an NAV per share.
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The NAV per share right
over here is $200.
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I just took the total NAV and I
just divided it by the shares.
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And what's special about
an open-ended mutual fund
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is at the close, or at
the end of every day,
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either new shares can
be removed from the fund
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or could be created
for the fund.
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So in the first
video, I showed how
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I wanted to buy into the
fund so I bought a share.
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And that increase the NAV.
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And it also increased
the number of shares.
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He had to create a
share for me to buy,
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he didn't sell me share
that already existed.
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So you can imagine, after
this type of performance
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more people would
want to buy shares.
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So now they would have
to buy in to make things
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fair at $200 per
share, because that's
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the current NAV per share.
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So let's say that five more
people want to buy in at $200
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per share.
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So what Pete would do, or
what this mutual fund--
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it's not Pete really,
it's the corporation--
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it would create five new shares.
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So one, two, three, four, five.
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If there was only
one person that day
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it would create
one share that day.
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If there was 10
people that they would
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create 10 shares that day.
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And it could keep doing this.
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And the NAV of each
of these are $200.
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So it gives the shares
to each of these people.
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And they had to contribute $200.
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So essentially it puts
another $1,000 into the pool
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that Pete can now manage.
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And so now the total NAV
for the fund is $2,000 now.
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And Pete will get his
1% management fee off
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of this entire $2,000.
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Now let's say that we
fast forward a little bit.
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We fast forward a
little bit to let's
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say Pete starts having
a not so good year.
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So let's say we fast
forward a year past that
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and Pete has a
negative 10% return.
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So if you started at
$2,000, and that's
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when you include taking
his management fee out,
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you start at $2,000, you
lose 10% in one year.
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So it goes down to $1,800.
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Let me do this in a new color.
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So now he's at $1,800.
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It's not completely
drawn to scale,
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but hopefully you get the idea.
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So now he is at $1,800.
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But you still have a
total of 10 shares.
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So let me do my best
to draw the 10 shares.
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So I have one, two, three, four,
five, six, seven, eight, nine,
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10.
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These should be of equal size.
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And now the NAV
per share is going
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to be 1,800 divided
by 10, or $180.
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And let's say that I
get a little bit freaked
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out by this recent performance.
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And I have some other
commitments with my money.
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So I say Pete, you need to
buy my share back from me.
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So what Pete does is he
would give me back $180.
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So the total NAV
would lose $180.
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So it would go down to $180.
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So we would take this out of it.
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1,800 minus 180 is 1,620.
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So now it is 1,620.
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And they would buy
back a share from me.
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So they would cancel
one of the shares.
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But notice, the NAV per
share does not change.
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By me redeeming my
share it does not
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change what happens
to everyone else.
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Now you have 1,620 divided by
9 shares, that should still
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get you to be $180 per share,
if I did my math right.
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So 1,800 minus 180
gets you 1,620.
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It should still be
one $180 per share.
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But this is the nature
of an open-ended fund.
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You can keep creating
shares and selling them
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to the public to
raise more money.
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Or when someone wants
their money back
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you essentially buy the
share back from them,
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give them their money
when you buy it back,
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and you remove that share.
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So an open-ended fund, really at
the close of every trading day,
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can keep growing or shrinking.
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It could be keep adding
more and more investors.
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Or their investors can
take their money back.
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What's difficult about this
from the fund manager's point
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of view, is that they
have to manage this.
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They have to manage
this constant buying
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and selling with the public.
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They have to manage
the paperwork.
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And if you think
about it, they can't
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have all of their money invested
in relatively illiquid assets,
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or even in regular stocks.
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They have to keep some
amount of their money.
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And it's usually like 3% to 5%.
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They have to keep some of this
$2,000 before he lost my money,
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they have to keep
some of it in cash.
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And from an investor's
point of view,
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they would say, well,
if I'm good at investing
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I should try to minimize the
amount of cash that I have
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because I'm not
getting return on cash.
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But because it's open-ended,
because investors
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might come by and say,
hey, I want my money,
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you have to have a little bit of
cash as part of the asset pool
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in order to be able to
buy people's shares back.
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