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Difficulty: HardInvestment Companies and Managed Funds

An investor submits orders at 2:00 PM EST to liquidate holdings in both a closed-end investment company and an open-end mutual fund. At the time of order entry, the closed-end fund's secondary market bid-ask quote is 18.50−18.50 - 18.60 with a published net asset value (NAV) of 20.00pershare,whiletheopen−endmutualfunddisplaysapriordayclosingNAVof20.00 per share, while the open-end mutual fund displays a prior day closing NAV of 20.00 per share. Assuming standard market operations and no applicable redemption fees, which of the following correctly describes the pricing mechanisms governing these two transactions?

  1. The closed-end fund shares sell at the prevailing market bid price of $18.50 per share, whereas the open-end mutual fund shares redeem based on forward pricing at the next calculated NAV determined after market close.Answer
  2. B
    Both transactions execute immediately at the published morning NAV of $20.00 per share because federal regulations require investment company redemptions to take place at net asset value.
  3. C
    The closed-end fund shares are redeemed directly by the issuing fund at the end-of-day NAV, while the open-end mutual fund shares trade continuously on secondary exchanges at the market bid price of $18.50 per share.
  4. D
    The closed-end fund shares sell at the market ask price of 18.60pershare,whiletheopen−endmutualfundsharesexecuteatthepriordayclosingNAVof18.60 per share, while the open-end mutual fund shares execute at the prior day closing NAV of 20.00 per share.

Answer

The closed-end fund shares sell at the prevailing market bid price of $18.50 per share, whereas the open-end mutual fund shares redeem based on forward pricing at the next calculated NAV determined after market close.
Closed-end fund shares trade on secondary market exchanges driven by supply and demand, so an investor selling shares receives the current market bid price ($18.50). In contrast, open-end mutual fund shares do not trade on exchanges; transactions are processed directly with the fund sponsor using forward pricing, meaning the redemption value is based on the next calculated net asset value determined after the 4:00 PM EST market close.

Step-by-Step Solution

1
Analyze closed-end fund trading mechanics
Closed-end management company shares trade in the secondary market (e.g., on stock exchanges). Sell orders execute at the current market bid price ($18.50), which can be at a discount or premium to NAV.
Closed-end fund pricing is driven by market supply and demand, not continuous NAV calculation.
2
Analyze open-end mutual fund trading and pricing mechanics
Open-end mutual fund shares do not trade on secondary exchanges. Purchases and redemptions occur directly with the fund sponsor using forward pricing.
Under SEC Rule 22c-1, orders to redeem open-end fund shares are executed at the next calculated NAV after order receipt (typically calculated at 4:00 PM EST market close).
3
Compare the execution outcomes for both orders submitted at 2:00 PM EST
The closed-end fund order executes intra-day at the bid price ($18.50), while the open-end mutual fund order waits until market close to redeem at the newly calculated end-of-day NAV.
Differentiates exchange-traded secondary market transactions from primary/continuous redemption forward pricing.

Key Concept

Secondary Market Pricing vs. Forward Pricing Mechanics in Investment Companies
Estimated Time:1m 30s
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Topics

Investment Companies and Managed Funds

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