Unit Pricing - Ch13

Discussion in 'SP2' started by Tu Doan, Feb 10, 2022.

  1. Tu Doan

    Tu Doan Member

    Hi
    I have some questions regarding the calculation process of the unit price stated in chapter 13 Unit Pricing (SP2 CMP 2021 p8 Ch13).

    Let's take the appropriation price as an example, from the described process, my understanding is as follows:
    + Six bullet points mentioned there refers to the calculation of the Net Asset Value (NAV) of the fund. The number of units is known with certainty at the valuation time.
    + The expenses mentioned in the second bullet refer to the expenses incurred due to the purchase of the new assets only, not the expenses incurred from the purchase of the current assets held by the fund (as they were already purchased).
    + Therefore, the Net Asset Value of the fund is not only influenced by the performance of the assets held by the fund, but also by the transactions that occurred within the period. For example, considering 2 cases: (1) the money in is 1000 and the money out is 300, giving the net money in of 700; and (2) the money in is 2000 and the money out is 500, giving the net money in of 1500, assuming that the transaction cost is 3% of the asset value, then the expenses incurred in (2) should be higher than in (1). Thus, the NAV in (2) should be higher than that in (1).

    Regarding the third point above, I believe that the bid price is affected by the choice of 'offer basis' or 'bid basis'. Is this the same as saying that the transactions that occurred within the valuation period can affect the unit price calculated? For example, if the net position is contracting rather than expanding, then the NAV should definitely be different, even if the performance of assets remains the same.

    Also, one further problem that I am not clear is that if my above interpretation is true, then the interest of the unit-holders, which is reflected by the unit price, is actually affected by the transaction of the unit that they were not involved in.

    Thank you very much for your answers :)
     
  2. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Tu Doan

    I'm afraid your interpretation of the expenses above is wrong. As you've said, if we did it that way then unit-holders would be affected by a transaction that they were not involved in. The basic equity principle requires us to avoid this situation.

    So instead, the expenses in the appropriation price calculation are the expenses that would need to be paid to buy all the existing assets now (ignoring the new purchases).

    An example may help. Consider a fund with assets of 1,000. Expenses are 1% of the purchase price. The number of units is 200. Then the unit price is:

    1,000 x 1.01 / 200 = 5.05

    Now let's say that a new investor wants to invest 101. This will buy assets of 100 and pay the expenses of 100 x 0.01 = 1. At the current unit price they would get 20 units as 101 = 20 x 5.05.

    We now need to check that this transaction hasn't affected the value of other investors' units. The assets are now 1000 + 100 = 1,100 and the units are now 200 + 20 = 220. The new unit price is:

    1,100 x 1.01 / 220 = 5.05

    and so the unit price is unchanged and we've achieved our desired aim of performing the transaction without affecting the value of other investors' units.

    I hope this example helps.

    Best wishes

    Mark
     
  3. Tu Doan

    Tu Doan Member

    Thank you very much for your reply, it is much clearer now.

    However, based on your explanation, I would like to obtain further clarification as follows:
    (1)
    If the expense of acquiring the new assets is different from the expenses that would need to be paid to buy all the existing assets now, for example, if it is 1.5% instead of 1%, then for 101, we will buy assets of 99.51 and pay the expenses of 1.49, while the customer would still receive 20 units. After this transaction, the new NAV is calculated as 1000 + 10 + 99.51 + 1.49 = 1111 and the unit price is therefore, 1111/220 = 5.05 => Is my interpretation here right?.
    (2)
    The net position affects the choice of basis - offer basis or bid basis, and thus, it does affect the NAV and hence the unit price?
    For example, for the assets of 1000 and selling expenses of 1% of the selling market price then the "bid-basis" unit price is:
    (1000 - 10 ) / 200 = 4.95
    (3)
    One more point I would like to confirm is whether the expenses mentioned here are the historical expenses, i.e., the expenses actually incurred when purchasing the existing assets or the current expenses that would be incurred if we purchase the existing assets of the fund?
    As from your explanation and the course note, I think it should be the current expenses that would be incurred if we purchase the existing assets of the fund.
    If that is true then those expenses are very likely the estimated expenses as the expenses in acquiring some assets may be different over time or hard to determine (such as the change in transaction cost of share, or the settlement cost of the property, etc). As they are estimated figures, if we need to settle the transaction in reality then does it mean that any gain or loss should be born by the insurer? => Is this a risk for an insurer?

    Thank you again for your explanation.
     
  4. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Tu Doan

    I'll answer each of your questions in turn.

    1. I think you are over-complicating things here. This is not a situation we will meet in the exam. But the principle is that we would use the expenses of having to buy all the assets in the fund.

    2. Yes, that's right. If we are pricing on the bid basis (for a contracting fund) then we subtract the expenses.

    3. Yes, these are the current expenses, as we will be using the current expenses to buy/sell the assets to create/cancel the units. You're right that unit pricing often needs some assumptions. These assumptions will be a best estimate to avoid deliberately advantaging one party over another. But no, it will not be the insurer that covers any error here - it is accepted that the costs can't be known with complete precision.

    Best wishes

    Mark
     
  5. Tu Doan

    Tu Doan Member

    Thank you very much Mr. Willder. Your explaination is very clear and helpful :)
     

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