Ch 16: Unit pricing

Question 1

Unit pricing high-level overview. One sentence what it is and when complications arise

Answer 1

• At its simplest, assess the value of assets attributable to one unit in the fund
• Complications may arise:
  * If company is creating new units (will have to buy more of underlying assets)
  * If company is cancelling units (will have to sell some of the underlying assets)

Question 2

Management box description

In contect of unit pricing

Answer 2

• Create more units in fund than is strictly necessary to cover the corresponding unit liabilities.
• This excess is useful in management (some days there may be more PHs selling units, while on other days there may be more PHs buying units) thus the excess can help to reduce the need to cancel and create units each day.

Question 3

Risks relating to the maintaining of a management box.

Answer 3

• Risk that the value of the underlying assets go down, so value of the units held by company for its own account decreases
• Risk that the expenses of managing such a box is greater than expected
• Operational risks (eg keeping track of which units belong to PH and which to the company)

Question 4

Unit pricing risks: (5)

Answer 4

• Unit prices are generally set at discrete points in time, whereas tye underlying assets change continuously.
  * Any timing delay in adjusting the unit price introduces pricing risk to the company due to the mismatch between the companies liabilities (dependent on the unit price) and the value of the underlying assets.
• Unit price calculation would include some approximations including:
  * Allowance for tax on unrealised gains
  * Allowance for accrued assets and liabilities (accrued interest not yet received)
  * Estimates of market value of assets, where the market value is not immediately observable.
• Policy wording may dictate how the company will determine unit prices (has to be followed, changing this may invalidate PRE)
• Operational risks in the calculation of unit prices
  * Company uses wrong basis for calc
  * Unit prices based on incorrect data (asset managers provided incorrect market value of assets)
  * Error in calculation process/method
• Frequency of pricing important, as if too infrequent, possible that PH can withdraw just after a market crash, without unit prices being updated to reflect that. Company loses out.

Question 5

Equity principle of unit pricing

Answer 5

• Interests of unit-holders not involved in a unit transaction should be unaffected by that transaction
• In practice the creation and cancellation of other units can affect the price of a unit, however the company will wish to follow the above principe in its pricing.

Question 6

Appropriation price description

Answer 6

• Following from the basic equity principle, the amount of money put into the fund for each new unit created, should be such that the net asset value per unit is the same after as before creation.
• This amount of money per unit is known as the appropriation price
• Thus the price at which the company will create a unit

Question 7

Expropriation price description

Answer 7

• Following from the basic equity principle, the amount of money the company takes out of the fund for each unit cancelled is such that the net asset value per unit is the same after as before cancellation
• This money per unit is known as the expropriation price
• The price at which the company will cancel units

Question 8

Calculation process of appropriation prices (net asset value of fund on offer basis)

Answer 8

• Market “offer price” (sell price) value of the assets held by the fund
• Plus expenses incurred in purchase
• Plus value of any current assets sold but not yet settled
• less the value of any current liabilities (such as investments purchased but not yet settled)
• Plus any accrued income net of charges
• less allowance for accrued tax (if applicable)
• This gives the net asset value of the fund on offer basis
• This divided by the amount of units existing at valuation date will give the appropriation price.

Question 9

Calculation process for expropriation price

Answer 9

• Similar to apropriation price calc, but start with bid value of the fund held and expenses that would be incurred are deducted
• Results in net asset value of fund on bid basis
• Again divide by number of units

Question 10

Offer and bid prices

Answer 10

• Under both bases (offer basis and bid basis) there will be offer and bid prices

Question 11

Offer and bid prices on offer basis

Answer 11

• Company is net creator of units.
• Offer and bid prices are determined from the appropriation price
• For commercial and practical reasons, adjustments will be made:
  * Initial charges on creation of units, is in addition to appropriation price. (thus offer price = appropriation price + initial charge and bid price is just the appropriation price)
  * Rounding (quoted to certain decimal places, normal round up on offer and down on bid)