Mutual Fund Transactions
Understanding how mutual fund transactions are processed is essential for serving customers and passing the Series 6 exam. This includes purchase and redemption procedures, pricing rules, and settlement requirements.
Forward Pricing Rule (Rule 22c-1)
SEC Rule 22c-1 establishes the forward pricing requirement for mutual funds:
Forward Pricing: All purchase and redemption orders receive the NEXT calculated Net Asset Value (NAV), not the NAV at the time of order placement.
How Forward Pricing Works
| Order Timing | NAV Applied |
|---|---|
| Order received before 4:00 PM ET | Same day's NAV |
| Order received after 4:00 PM ET | Next business day's NAV |
Key Point: Investors don't know the exact price they'll receive when placing an order. They learn the price after the NAV is calculated following market close.
4:00 PM ET Cut-Off
- 4:00 PM ET is the standard cut-off for most funds
- Coincides with NYSE market close
- Orders must be received in "good order" by cut-off
- Some funds may have earlier cut-offs
Purpose of Forward Pricing
Forward pricing prevents:
- Late trading - Placing orders after knowing the day's NAV
- Market timing - Exploiting stale prices in fund holdings
- Dilution - Unfair advantage over existing shareholders
Purchase Orders
How to Buy Mutual Fund Shares
| Method | Description |
|---|---|
| Lump Sum | One-time purchase of shares |
| Systematic Investment | Automatic periodic purchases |
| Exchange | Transfer from another fund in same family |
| Dividend Reinvestment | Automatically reinvest distributions |
Good Order Requirements
For an order to be in "good order," it must include:
- Customer name and account number
- Fund name or ticker symbol
- Dollar amount or number of shares
- Type of order (buy, sell, exchange)
- Customer authorization (signature or equivalent)
- Payment (for purchases)
Purchase Price Calculation
| Fund Type | Purchase Price |
|---|---|
| No-load fund | NAV |
| Load fund | NAV + Sales Charge = POP (Public Offering Price) |
POP Formula:
POP = NAV / (1 - Sales Charge %)
Example: NAV = $10.00, Sales Charge = 5% POP = $10.00 / (1 - 0.05) = $10.00 / 0.95 = $10.53
Redemption Orders
How to Sell Mutual Fund Shares
Shareholders can redeem shares by:
- Written request to the fund
- Telephone redemption (if authorized)
- Online transaction (if available)
- Through financial advisor
Redemption Price
| Situation | Redemption Price |
|---|---|
| No back-end load | NAV |
| Back-end load (CDSC) | NAV minus applicable charge |
Redemption Fees vs. CDSC
| Fee Type | Purpose | Recipient |
|---|---|---|
| CDSC (Contingent Deferred Sales Charge) | Compensate distributor for sales expense | Distributor/adviser |
| Redemption Fee | Discourage short-term trading | Fund (benefits remaining shareholders) |
SEC limits redemption fees to a maximum of 2% under Rule 22c-2.
Mandatory Redemption Payment Timing
Funds must pay redemption proceeds within 7 calendar days of receiving a redemption request in good order.
Exceptions allowing delay:
- NYSE is closed (other than weekends/holidays)
- Emergency conditions declared by SEC
- Investor recently deposited check (may wait for clearance)
Settlement
T+1 Settlement (Effective May 28, 2024)
| Transaction Type | Settlement |
|---|---|
| Mutual fund purchase | T+1 (trade date + 1 business day) |
| Mutual fund redemption | T+1 |
| Exchange within fund family | Same day or T+1 |
Note: The May 28, 2024 T+1 settlement date is historical - when the rule took effect.
Payment Requirements
- Purchases: Payment due by settlement date
- Redemptions: Proceeds sent by settlement date
- Reg T: Not applicable to mutual funds (only margin securities)
Systematic Investment Plans
Dollar Cost Averaging
Investing a fixed dollar amount at regular intervals:
| Month | Investment | NAV | Shares Purchased |
|---|---|---|---|
| Jan | $500 | $10.00 | 50.00 |
| Feb | $500 | $8.00 | 62.50 |
| Mar | $500 | $12.50 | 40.00 |
| Apr | $500 | $10.00 | 50.00 |
| Total | $2,000 | Avg: $10.13 | 202.50 |
Average cost per share: $2,000 / 202.50 = $9.88
Key Point: Average cost ($9.88) is LESS than average NAV ($10.13) because more shares are purchased when prices are low.
Benefits of Systematic Investing
- Removes emotion from investing
- Automatic discipline
- Dollar cost averaging effect
- Potential for breakpoint achievement over time
Exchanges Within Fund Families
Exchange Privileges
Most fund families allow exchanges between funds:
- Usually at NAV (no new sales charge for Class A)
- May be limited in frequency
- Subject to prospectus terms
Tax Treatment of Exchanges
Important: Exchanges are TAXABLE events, even within the same fund family.
An exchange is treated as:
- Sale of original fund shares (taxable gain/loss)
- Purchase of new fund shares (new cost basis)
Key Exam Points
- Forward pricing - Orders get NEXT calculated NAV
- 4:00 PM ET cut-off - Standard for most funds
- 7-day redemption - Maximum time to pay redemption proceeds
- T+1 settlement - Trade date plus one business day
- Exchanges are taxable - Even within same fund family
- Dollar cost averaging - Average cost less than average price
- POP = NAV + Sales Charge - For load funds
Under SEC Rule 22c-1, a customer places a mutual fund purchase order at 3:30 PM ET. Which NAV will be used to price the transaction?
By law, within how many days must a mutual fund company pay redemption proceeds to a shareholder?
A customer exchanges shares from one mutual fund to another within the same fund family. How is this exchange treated for tax purposes?
6.2 Variable Annuity Transactions
Continue learning