Open-ended Funds
Net asset value is most commonly used in the context of open-end funds. Shares and interests in such funds are not traded between investors, but are issued by the fund to each new investor and redeemed back to the fund when an investor withdraws. A fund will issue and redeem shares and interests at a price calculated by reference to the NAV of the fund, with the intention that new investors receive a fair proportion of the fund and redeeming investors receive a fair proportion of the fund's value in cash.
As a numerical example, if a fund has a NAV of $200 million and 1 million shares in issue on a certain day, the "NAV per share", being the price at which the shares will be issued, is $200. A person investing $40 million on that day will therefore be given 200,000 shares. Immediately following his investment the total NAV of the fund will be US$240MN, as the new investor's cash becomes part of the fund and is available for investment by the fund. The investor will then be entitled to 1/6 of the fund's value when he withdraws his investment, proportionately adjusted for any subsequent profits or losses.
The valuation of the assets and liabilities of an open-ended fund is therefore very important to investors. If the NAV in the above example had, with the same assets, been calculated as US$160MM (and the NAV per share as $160), the investor would have been given 250,000 shares and would become entitled to 1/5 of the fund's value.
In contrast, closed-end funds are traded in the open market between investors and so the price of shares or interests in a closed-end fund will be whatever the parties agree it to be, which may not correspond to the fund's NAV. Publicly traded shares in such funds generally trade at a price below NAV.
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