1. Late trading: This behavior occurs when orders are accepted after the official trading cutoff time (typically 4:00 pm) but are priced at the NAV (Net Asset Value) determined at the end of the trading day. Late trading gives an unfair advantage to those who have access to information about events occurring after the official trading deadline.
Example: Let's say the stock market closes at 4:00 pm, and a mutual fund receives an order to buy shares at 4:05 pm. However, the order is processed as if it was placed before 4:00 pm, meaning the buyer can take advantage of any market-moving news or events that occurred after the official closing time.
2. Market timing: This behavior involves exploiting stale pricing in the mutual fund's NAV calculation. Market timers try to buy or sell shares at an outdated NAV, taking advantage of price discrepancies caused by market events occurring shortly before the NAV is calculated.
Example: Suppose a mutual fund invests in international stocks, and the fund's NAV is calculated based on the closing prices of foreign markets. Due to time zone differences, some market events in those foreign markets may not be fully reflected in the mutual fund's NAV, enabling market timers to execute trades at prices that don't fully reflect the latest market developments.
3. Front running: Front running occurs when someone trades in anticipation of a large trade to be executed by a mutual fund, attempting to profit from the expected price movement caused by the fund's trade.
Example: A mutual fund announces its intention to buy a large number of shares of a specific company. Before the fund can execute the trade, a dishonest trader buys shares of that company for their own account, expecting the stock's price to rise when the mutual fund makes its purchase. The front runner can then sell their shares at a profit.
4. Directed brokerage: This behavior involves a quid pro quo arrangement between a mutual fund and a broker. The fund directs its trades to the broker in exchange for the broker encouraging its clients to invest in the mutual fund.
Example: A mutual fund company may have an agreement with a specific brokerage firm, whereby the fund promises to channel a certain amount of trading business to the broker. In return, the broker encourages its clients to invest in the mutual fund, which may lead to increased assets under management for the fund.
It's essential to identify and discourage these undesirable trading behaviors in mutual funds to maintain fair and transparent markets and protect the interests of all investors. Regulators and industry bodies closely monitor such activities and impose penalties for illegal trading practices to ensure market integrity and investor confidence.
Certainly! Here are some multiple-choice questions related to potential undesirable trading behaviors among mutual funds:
Question 1:
What is late trading in the context of mutual funds?
A) Buying and selling shares of a mutual fund after the official trading cutoff time but at the updated NAV.
B) Submitting orders to buy or sell mutual fund shares after the official trading cutoff time but pricing them at the end of the trading day.
C) Executing trades in anticipation of a large trade to be executed by a mutual fund.
D) Engaging in a quid pro quo arrangement between a mutual fund and a broker for directing trades.
Answer: B) Submitting orders to buy or sell mutual fund shares after the official trading cutoff time but pricing them at the end of the trading day.
Question 2:
What is the primary concern with market timing in mutual funds?
A) It can lead to significant fluctuations in the fund's size, affecting its liquidity.
B) It provides an unfair advantage to those with access to information about market events after the official trading cutoff time.
C) It involves trading ahead of a likely price increase or decrease due to a known upcoming trade by the fund.
D) It encourages brokers to invest their clients in the mutual fund in exchange for directing trades to the broker.
Answer: A) It can lead to significant fluctuations in the fund's size, affecting its liquidity.
Question 3:
Which of the following undesirable trading behaviors is considered illegal and subject to prosecution?
A) Market timing
B) Late trading
C) Directed brokerage
D) Front running
Answer: B) Late trading
Question 4:
What is front running in the context of mutual funds?
A) Executing trades after the official trading cutoff time but pricing them at the end of the trading day.
B) Exploiting stale pricing in the mutual fund's NAV calculation to profit from price discrepancies.
C) Trading ahead of a likely price increase or decrease due to a known upcoming trade by the mutual fund.
D) Engaging in a quid pro quo arrangement between a mutual fund and a broker for directing trades.
Answer: C) Trading ahead of a likely price increase or decrease due to a known upcoming trade by the mutual fund.
Question 5:
Which of the following undesirable trading behaviors is not illegal but strongly discouraged?
A) Market timing
B) Late trading
C) Directed brokerage
D) Front running
Answer: C) Directed brokerage
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