Question

You are evaluating a closed-end mutual fund and see that its price is different from its net asset value (NAV). The fund has an expense ratio (ε) of 3.23% and a dividend yield (δ) of 4.00%. The fund has experienced a risk-adjusted abnormal return (α) of 2.81%.

By what amount (premium or discount) is the fund likely to trade relative to its NAV? (Round your answer to 2 decimal places. Use a negative sign to indicate a discount.)

Answer 1

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Answer:

As the expense ratio is greater than the risk-adjusted abnormal return, the bond will sell at a discount. The amount of discount can be determined with the use of following formula:

Amount of Discount = (Risk-Adjusted Abnormal Return - Expense Ratio)/(Dividend Yield + Expense Ratio - Risk-Adjusted Abnormal Return)

Using the values provided in the question in the above formula, we get,

Amount of Discount = (2.81% - 3.23%)/(4% + 3.23% - 2.81%) = -9.50% (the negative sign indicates discount)