Packaged Securities - Net Asset Value (NAV)

As previously discussed, the shares of closed-end funds trade on an exchange, and the market will determine their prices, but the prices for shares of mutual funds are based on NAV.

Say, for example, you just established a balanced fund and today you issue your first shares to the public. You have published a prospectus stating that you are starting with $100,000,000 in cash. Your starting NAV is easy enough to determine: $100,000,000.

But tomorrow it will be harder to compute because of two complications:

  1. First, you will have invested your cash in stocks, bonds and money-market instruments, and you will have to deal with their changes in market price as well as accrual of interest and dividends.

  2. Second, you will have issued shares, let's say 1,000,000 of them - and the important number is not NAV itself, but NAV per share, or NAVPS.

Here's how you calculate NAVPS:

  1. Take the market value of all the assets in the fund. In this example, let's assume the market had a very good day, and the assets you bought in the morning appreciated an average of 3% by end of trading. Your assets would be valued at $103,000,000.

  2. Subtract liabilities. Assume it costs a fixed $1,000,000 to advise and manage the fund for the year, and there is a contract in place making this a formal liability. Your NAV, then, would be $102,000,000.

  3. Divide the NAV from step 2 by the number of shares issued. In this case, you issued 1,000,000 shares, so your NAV is $102 ($102,000,000 divided by 1,000,000 shares).

Bid vs. Offering Prices
NAV per share is considered the share's bid price, or the price the fund actually receives when it sells a share, and it must be calculated daily. The bid price is different from the offering price. Let's say that, between the selling group members and the underwriter, the sales charges come in at 8%. Remember, that is not 8% of the bid price, it is 8% of the offering price. You cannot get to the offering price by adding the sales charge.

Here's how you calculate the offering price:

  1. Take the sales charge percentage and subtract it from 1. In the case of an 8% sales charge, the result is 0.92 (1.0 minus 0.08).

  2. Take the bid price and divide it by the result of step 1 to get the offering price. In this example in which the NAV per share is $102, the final result is $110.87 ($102 divided by 0.92).

Look Out!
If you simply tacked 8% onto $102, your result would be $110.16, and that would be wrong. You can bet the Series 7 exam will have at least one trick answer like that.

The NAV-based formula for computing the public offering price must be included in the mutual fund's prospectus, which must be updated at least every 16 months.

Dollar Cost Averaging
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