2.1 investment company securities

75-5-10 test

- 75% of total assests must be invested in securities issued by companies other than the investment compnay or its affiliates -of this 75% no more than 5% of total assets can be invested in any one corporations securities - of this 75% the investment company cant own more than 10% of an outside corporations voting class securities (common stock)

what does the Investment company act of 1940 classify investment companies as? (3)

- FAC (face amount certificate) -UIT (unit investment trusts) -Management investment companies

function of UIT as trust

- UIT trustess typically but other investment company shares or indivdual stocks or bonds to create the desired portfolio -then sell redemable shares known as units or shares of beneficial interest

Hedge Funds

- are a form of fund generally organized as a limited partnership with fewer than 100 investors that does not currently have to register with the SEC, although the portfolio managers generally are required to register as investment advisers. - funds are free to adopt far riskier investment policies than those open to ordinary mutual funds, such as arbitrage strategies and massive short positions during bearish markets. In addition, they may use leverage (borrowed money) and derivatives such as options and futures. Hedge funds are considered to be in the asset class of "alternative" investments. Even though these risky techniques are employed, the primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

FAC's

- contract between an investor and an issuer in which the issuer guarantees payment of a fixed sum to the investor at some set date in the future

characteristics of UIT (3)

- do not have boards of directors - do not employ an investment adviser - do not activley manage their own portfolios (trade securities) - may be fixed or non fixed

open end investment companies *POP =

- does not specify number of shares it intends to issue -can raise unlimited amount of investment capital by continuously issuing new shares -investor buys shares directly from company or its underwriters at the POP (public offering price) =NAV pershare plus any aplicable sales charges - sells redeemable securities

shares of UIT (aka shares of beneficial interest)

- each share is an undivided interest in the underlying portfolio -because not managed, when securities in portfolio are liquidated or called, proceeds must be distributed

investment company

- individuals invest in large diversified portfolios of securities by pooling their funds with other investors funds - individuals gain some of the advantages large investors enjoy such as diversification of investment lower transaction costs and professional management - raise capital by selling shares to the public

FAC companies

- issuers of these types of investments - few exist today because tax law changes have elimanted their tax advantages

N.A.V

- net asset value -NAV = fund liabilities - total assests -NAV per share= fund NAV/ # outstanding shares -mutual funds or open end investment companies must compute NAV once a day -close end compute once a week

UIT known features

- not activley managed; no board of directors or investment adviser - must be redeemed by the trust - are investment companies as defined under the investment company act of 1940

mutual fund

- open end investment management - pool of investors money is invested in various securities determined by the funds objective -must redeem shares at the NAV -offer guaranteed marketability because ther is always a willing buyer for the shares - may be purchased in full or fractional units -capital shrinks when investors redeem their shares

3 important features of FAC's

- pay fixed rate of return - do not trade in the secondary market, redeemed by issuer - companies are classified as investment companies

diversified company

- provides risk management that makes mutual funds popular with many investors - under investment company act of 1940 company qualifies as diversified if it meets 75-5-10 test

nonfixed UIT

- purchases shares of an underlying mutual fund

fixed UIT (past/present)

- typically purchases a portolio of bonds an terminates when the bonds in the portfolio mature - in past were almost exclusively a portfolio of bonds, now percentage consist of portfolio of equities - since equities dont have maturity date, liquidation date is set in offereing documents

UIT's

- unmanaged investment company organized under a true indenture

investor in mutual fund

-each investor owns an undivided interest in the entire underlying portfolio - no one investor has preferred status because mutual funds issue only on class of common stock - each investor shares mutually with other investors in gains and distributions derived ffrom the portfolio - share in funds performance based on number of shares owned - can think in terms of dollars rather than # of shares owned

management investment company

-most familiar -activley manages securities portolfio to achieve a stated investment objective -either open or closed end -initially both sell shares to the public difference is the type of securities they sell and how investors buy and sell their shares

closed end investment companies *referred to as *bid price *ask price

-to raise capital conducts a common stock offering -intitial offering company registers a fixed number of shares with the sec and offers them to the public for a limited time though an underwriting group -can also issue bonds and preferred stock -referred to as publicily traded funds -supply and dmand determined by bid price (price at which an investor can sell) as well as ask price (price at which investor can buy)

UIT under Investment company act of 1940

-trustees of both fixed and non fixed UITs must maintain secondary markets in the units, allowing unit holders the ability to redeem their units

combination privilege

A mutual fund company frequently offers more than one fund and refers to these multiple offerings as its family of funds. An investor seeking a reduced sales charge may be allowed to combine separate investments in two or more funds within the same family to reach a breakpoint.

open end funds

All sales commissions are paid from the sales charges collected. Sales charges include commissions for the managing underwriter, dealers, brokers, and registered representatives, as well as all expenses incurred in communications with the public.

stock funds (7)

Common stocks normally provide the growth component of any mutual fund that has growth as a primary objective. Preferred, utility, and large-cap stocks are typically used to provide the income component of any stock mutual fund that has income as a primary objective. Although there are other categories (to be covered in Unit 6), at this point you need to know the difference between large-cap and small-cap stocks. The term, "cap" refers to the company's market capitalization (the number of outstanding common shares multiplied by the current market price per share). For example, a company with 30 million shares outstanding where the price per share is $30 has a market cap of $900 million. As you will see again in Unit 6, a market cap of $300 million to $2 billion is considered small-cap, while that of more than $10 billion is considered large-cap. It is generally felt that the larger the market cap, the more conservative the investment. growth, income, combination, specialized, special situation, index, foreign stock

sales charges

FINRA prohibits its members who underwrite fund shares from assessing sales charges in excess of 8.5% of the POP on the purchase of open-end investment company shares. The actual schedule of sales charges is specified in the prospectus.

breakpoint sales

FINRA prohibits registered representatives from making higher commissions by selling investment company shares in a dollar amount just below the point at which the sales charge is reduced. This is known as a breakpoint sale. FINRA considers this practice contrary to just and equitable principles of trade. It is the responsibility of the principal to prevent breakpoint selling.

escrow and escrowed shares

LOI is a one-sided contract binding on the fund only. The customer must complete the intended investment to qualify for the reduced sales charge. The fund holds the extra shares purchased as a result of the reduced sales charge in escrow. If the customer deposits suffcient money to complete the LOI, he receives the escrowed shares. Appreciation and reinvested dividends do not count toward the LOI.

exchanges within family funds

Many investment companies offer the exchange or conversion privilege within their families of funds.

taxation when comparing mutual funds

Mutual fund investors pay taxes on income and capital gains distributed by the fund. Dividends that qualify are taxed at 15%; for test purposes, all capital gains distributions are from the fund's long term gains, so they are taxed at 15% to the investor.

12b-1 Asset Based Fees

Mutual funds cannot act as distributors for their own fund shares except under Section 12b-1 of the Investment Company Act of 1940. This provision permits a mutual fund to collect a fee for promotion or sales-related activities in connection with the distribution of its shares. The fee is determined as a fat dollar amount or as a percentage of the fund's average total NAV during the year. The fee is disclosed in the fund's prospectus. percentage of net assets charged must be reasonable (typically .5% of net assets—this annual fee cannot exceed .75% of net assets), and the fee must reflect the anticipated level of distribution services. If the fee exceeds .25%, the fund cannot use the term no-load.

classes of fund shares and fee types (3)

Mutual funds may offer several classes of shares to allow investors to select how they pay the sales charges. The following is a typical method by which firms may classify fund shares by fee type: Class A, B, and C shares. ■ Class A shares (front-end load): investors pay the charge at the time of purchase. ■ Class B shares (back-end load): declines over time so investors pay the charge at redemption. ■ Class C shares (level load): no sales charge to purchase, generally a 1% CDSC for one year, with a continuous 12b-1 charge.

investment objectives

Once a mutual fund defines its objective, its portfolio is invested to match it. The objective must be clearly stated in the mutual fund's prospectus and can be changed only by a majority vote of the fund's outstanding shares.

costs when comparing mutual funds

Sales loads, management fees, and operating expenses reduce an investor's returns because they diminish the amount of money invested in a fund. Historically, mutual funds have charged front-end loads of up to 8.5% of the money invested (public offering price). This percentage serves as a sales commission to a sales force and other expenses associated with selling the shares. Many low-load funds charge between 2% and 5%. Additionally, funds may charge a back-end load when funds are withdrawn. Some funds charge ongoing fees under section 12b-1 of the Investment Company Act of 1940. These funds deduct annual fees to pay for marketing and distribution costs

performance when comparing mutual funds

Securities law requires that each fund disclose the average annual total returns for 1, 5, and 10 years or since inception. The manager's track record in keeping with the fund's objectives, as stated in the prospectus, is important as well. Returns must be expressed assuming maximum sales loads applied.

reduction in sales charges and what it must offer

The maximum permitted sales charge is reduced if an investment company does not offer certain features. To qualify for the maximum 8.5% sales charge, the investment company must offer both of the following: ■ Breakpoints—a scale of declining sales charges based on the amount invested ■ Rights of accumulation

breakpoints

The schedule of discounts a mutual fund offers is called the fund's breakpoints. Breakpoints are available to any person. For a breakpoint qualifcation, the term person includes married couples, parents and their minor children, and corporations. Investment clubs or associations formed for the purpose of investing do not qualify for breakpoints. sample in book and notes

exchange privileges

allow an investor to convert an investment in one fund for an equal investment in another fund in the same family at net asset value without incurring an additional sales charge. For example, someone who started investing when in their 30s or 40s by placing their money into an aggressive growth fund, might consider moving into something more conservative when they reached their 50s. Once they hit their 60s and 70s, they would want to have a greater percentage of their money in income funds. By staying in the same family of funds and using the exchange or conversion privilege, all of these changes could be made free of sales loads.

back end loads

also called a contingent deferred sales charge or load (CDSC), is charged at the time an investor redeems mutual fund shares. The sales load, a declining percentage charge that is reduced annually (for instance, 8% the first year, 7% the second, 6% the third, and so forth), is applied to the proceeds of any shares sold in that year. The back-end load is usually structured so that it drops to zero after six to eight years at which time they are converted to Class A shares with their lower operating expense ratios. They are frequently referred to as Class B shares.

dividend rates on money market funds

are neither fixed nor guaranteed and change often. The interest these funds earn and distribute as dividends is computed daily and credited to customer accounts monthly. In general, money market mutual funds offer check-writing privileges making for extraordinary liquidity.

money market funds

are no-load, open-end investment companies (mutual funds) that serve as temporary holding accounts for investors' money. are most suitable for investors whose financial goals require liquidity above all

front end loads

are refected in a fund's public offering price. The charges are added to the NAV at the time an investor buys shares. They are frequently referred to as Class A shares and have lower operating expense ratios than other classes.

special situation funds

buy securities of companies that may benefit from a change within the corporations or in the economy. Takeover candidates and turnaround situations are common investments.

combination funds

combination fund (also called a growth and income fund) may attempt to combine the objectives of growth and current income by diversifying its portfolio among companies showing long-term growth potential and companies paying high dividends.

specialized or sector funds

companies that choose to concentrate their assets in one industry or geographical area i.e. health care or tech. - company that invests in a single industry can still be diversified if it meets 75-5-10 test

advantages vs disadvantages 5vs2

diversification, professional management, convienience, liquidity, minimum initial investment vs risks and fees and expenses more in depth in sheet printed out

close end funds

do not carry sales charges. An investor pays a brokerage commission in an agency transaction or pays a markup or markdown in a principal transaction

net redemptions

excess of shareholder redemptions over new share purchases -when that occurs the portfolio manager is put in the position of deciding which assests to liquidate when prices are falling

ETFS

exchange traded funds This type of fund invests in a specific index, such as the S&P 500. Any class of asset that has a published index around it and is liquid can be made into an ETF so that there are ETFs for real estate and commodities as well as stocks and bonds. In this way, an ETF is similar to an index mutual fund. The difference is that the exchange-traded fund trades like a stock on an exchange or Nasdaq and, in this way, is similar to a closed-end investment company. The investor can take advantage of price changes that are due to the market, rather than just the underlying value of the stocks in the portfolio. ETFs can be purchased on margin and sold short, just like any other listed stock. Expenses tend to be lower than those of mutual funds as well because all the adviser has to do is match up to the specified index, so the fees are mini- mal. In addition, there can be tax advantages to owning ETFs. included in the term pooled investment vehicles. many are legally classified as unit investment trusts UITs with the rest as open end companies

funds expense ratio

expresses the management fees and operating expenses as a percentage of the fund's net assets. All mutual funds, load and no-load, have expense ratios. The expense ratio is calculated by dividing a fund's expenses by its average net assets. The sales charge is not generally considered an expense when calculating a fund's expense ratio

hedge fun fees

fees tend to be much, much higher than with other investments. Almost all hedge funds charge performance-based fees. The typical fee structure is known by the vernacular "2 & 20"—most funds take a 2% management fee and 20% of any profits.

suitability of mutual funds

first step is to determine the customers primary objective. basic rules: ■ Investors seeking growth should invest in stock funds. ■ Investors seeking income should invest in bond funds. ■ Investors who are concerned about safety of principal should invest in government bond funds. ■ Investors who are concerned with immediate liquidity should invest in money market funds. additional objectives on printed out page and notes

backdating the LOI

fund often permits a customer to sign an LOI as late as 90 days after an initial purchase. The LOI may be backdated by up to 90 days to include prior purchases but may not cover more than 13 months in total. This means that if the customer signs the LOI after 60 days, he has 11 months to complete the letter.

US government and agency securities funds

government funds purchase securities issued by the US Treasury or an agency of the US government, such as Ginnie Mae. Investors in these funds seek current income and maximum safety.

bond funds

have income as their primary investment objective. Some funds invest solely in investment-grade corporate bonds. Others, for enhanced safety, invest only in government issues. Others seek capital appreciation by investing in lower-rated issues that may be upgraded in the future.

fully paid FAC

if investor pays for the certificate in a lump sum, investment known as this

services offered when comparing mutual funds

include retirement accounts investment plans check writing privileges phone transfers conversion privileges combination investment plans withdrawal plans and others

tax free (tax exempt) bond funds

invest in municipal bonds or notes that produce income exempt from federal income tax. Tax-free funds can invest in municipal bonds and tax-exempt money market instruments. Please note that any capital gains distributions from the fund are taxable just as with any other fund.

index funds

invest in securities to mirror a market index, such as the S&P 500. An index fund buys and sells securities in a manner that mirrors the composition of the selected index. The fund's performance tracks the underlying index's performance. This approach reflects the passive style of portfolio management, as opposed to active portfolio management. Turnover of securities in an index fund's portfolio is minimal. As a result, an index fund generally has lower management costs than other types of funds. Furthermore, because index funds have little turnover, they frequently appeal to investors seeking minimal taxable capital gains

balanced funds

invest in stocks for appreciation and bonds for income and different types of securities are purchased according to a formula a balanced funds portfolio might contain 60% stocks and 40% bonds

growth funds

invest in stocks of rapidly growing corporations - growth companies tend to reinvest all or most of their profits for research and development rather than pay dividends - Growth funds are focused on generating capital gains rather than income. Aggressive growth funds tend to concentrate more in small-cap stocks, while conservative growth funds have a preponderance of large-cap issues.

foreign stock funds

invest mostly in the securities of companies that have their principal business activities outside the United States. Long-term capital appreciation is their primary objective, although some funds also seek current income. Foreign investments involve foreign currency risks, as well as the usual risks associated with stock investments.

comparing mutual funds (5)

investors should select funds that match their personal and financial objectives. when compaing funds with similar objectives the investo shoulw review information regarding funds -performance - costs -taxation -portfolio turnover -services offered

nav on money market funds

is fixed at $1 per share. Although this price is not guar- anteed, a fund is managed in order not to "break the buck" regardless of market changes. Thus, the price of money market shares does not fluctuate in response to changing interest rates.

LOI

letter of intent person who plans to invest more money with the same mutual fund company may decrease overall sales charges by signing a letter of intent (LOI). In the LOI, the investor informs the investment company that he intends to invest the additional funds necessary to reach the breakpoint within 13 months. - is a one-sided contract binding on the fund only.

rights of accumulation

like LOIs, allow an investor to qualify for reduced sales charges.

no load

means that investors pay no sales or liquidation fees

family funds

mutual fund company frequently offers more than one fund and refers to these multiple offerings as its family of funds.

pooled investment vehicles

phrase derived through the way many investors combine their investment capital

forward pricing

price determination for purchases and sales based upon the forward pricing principle -whenever order is received the price is based upon the next computed NAV per share i.e. any order received prior to 4 pm will be effected at the price cmputed as of that days market close

investment company act of 1940

provides for securities and exchange commission (sec) regulation of investment companies and their activities

portfolio turnover rate

reflects a fund's holding period. If a fund has a turnover rate of 100%, it holds its securities, on average, for less than one year. Therefore, all gains are likely to be short term and subject to the maximum tax rate. On the other hand, a portfolio with a turnover rate of 25% has an average holding period of four years, and most gains are taxed at the long-term rate. It is not uncommon for an aggressive growth fund to reflect an annual turnover rate of 100% or more. High portfolio turnover generally increases a fund's expense ratio.

requirements of hedge fund

require that investors maintain the investment for a minimum length of time (e.g., one year) and, to that extent, they can be considered illiquid. These requirements are known as lock-up provisions. This provision provides that, during a certain initial period, an investor may not make a withdrawal from the fund—the investor's capital is locked up. Generally recognized as one way the manager of the hedge fund portfolio can have capital retained in the fund, it is also seen to be another factor adding to the unique risk of hedge funds—in this case, shares being illiquid for that specified length of time.

specialized sector funds

specialize in particular economic sectors or industries. Others specialize in geographic areas such as the BRIC countries or the Pacific Rim. The funds have 25-100% of their assets invested in their specialties and are more likely than other funds to stick to a relatively fixed allocation.

asset allocation funds

split investments between stocks for growth bonds for income and money market instruments or cash for stability. the fund adviser switches the percentage of holdings in each asset category according to the performance or expected performance of that group

income funds

stresses current income over growth. The fund's objective may be accomplished by investing in the stocks of companies with long histories of dividend payments, such as utility company stocks, large-cap stocks, and preferred stocks.

UIT

unit investment trusts

methods mutual funds use to collect fees (3)

■ Front-end loads (difference between POP and net NAV) ■ Back-end loads (contingent deferred sales loads) ■ 12b-1 fees (asset-based fees, technically not a sales charge)

restirictions on money market funds (4)

■ The front cover of every prospectus must prominently disclose that an investment in a money market fund is neither insured nor guaranteed by the US government and that an investor has no assurance the fund will be able to maintain a stable NAV. This statement must also appear in all literature used to market the fund. ■ No more than 5% of a fund's assets may be invested in any one issuer's securities. ■ Investments are limited to securities with remaining maturities of 397 days or less, with average portfolio maturity not exceeding 90 days. ■ Investments are limited to securities that have received a rating from a recognized rating agency in one of the two highest short-tem rating categories.

differences between rights of accumulation and LOI's (3)

■ are available for subsequent investment and do not apply to initial transactions; ■ allow the investor to use prior share appreciation to qualify for breakpoints; and ■ do not impose time limits.