Stronghold Money Fund is a relatively new money market fund with about

QUESTION

Stronghold Money Fund is a relatively new money market fund with about $400 million in total financial assets and shares outstanding (each maintained at a value of $1.00 per share). Most of the funds accounts represent the savings of high-income, interest-sensitive investors. Stronghold&rsquo
Anytime you get a “theory” type finance question you want to start by reasoning through it logically. Look at the facts they give you and make conclusions, fact by fact. Then once you have an idea of the conclusions youve made, put in some finance principles for an A answer. The first thing I noticed is the funds holdings. Theyre highly concentrated in US government securities which have a lower yield than commercial paper and bank CDs. Next their average maturity is less than the industry average. We can assume the yield curve is upward sloping (it almost always is) and so the longer the term to maturity the higher the yield. Since this fund has a shorter term to maturity it will have a lower yield. -Then, the key to answer an impending interest rate rise. A basic principle of finance is that as rates rise the value current fixed securities decreases. The best way for this fund to prepare for an interest rate rise would be to hold debt with a shorter term or hold more cash. But this is a problem since they want to raise their current yield. *The best solution is Hold short term securities so youre ready for the rate increase, but move the holdings to commercial paper and bank CDs so you keep the current yield up. Ok, with these three points in mind an example answer With an impending interest rate rise Stronghold Money Fund

should hold shorter term securities. A portfolio made up of shorter term securities would give the fund more flexibility to move into securities with higher rates in the future. Longer term securities are also more sensitive to a rise in interest rates. Even though the fund is currently below the industry average in days to maturity, I would still recommend a distribution with an even shorter term to maturity. This would but Stronghold Money Fund in the best position to capitalize on the impending interest rate rise. To combat the low current yield the fund should invest more of its holdings in prime CDs and commercial paper. While these securities are slightly riskier than federal government debt, they come with higher yields that would improve the low current yield. This approach would allow the fund to improve its current yield while still positioning it to take advantage of a rate increase.

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