5.5 Investment Company Securities

A customer is interested in an exchange-traded fund (ETF). With regard to the trading of ETFs, the customer should be aware that: ETFs can be purchased throughout the trading day. ETFs use forward pricing, as all mutual funds do. real-time quotes are available for ETFs. the NAV calculated at the end of the day, plus a sales charge, will equal the trading price. A) I and III. B) I and IV. C) II and III. D) II and IV.

A) I and III. ETFs can be traded throughout the trading day. Changing price quotes are available in real time as investors buy and sell. Although ETFs have an NAV that is calculated on the basis of the portfolio holdings, the trading price is determined by supply and demand in the open market, with customers paying commissions.

You have a client who wishes to invest $100 per month into something that will give him the opportunity to share in the long-term growth prospects of the overall economy. Which of the following would probably be the most cost efficient investment vehicle? A) Class A shares of a large-cap growth fund. B) A no-load index mutual fund that mimics the S&P 500. C) A fund of hedge funds. D) An exchange traded fund (ETF) that mimics the S&P 500.

B) A no-load index mutual fund that mimics the S&P 500. Although there is possible room to argue, weÂ'll go with what the exam would choose. The only other logical choice is the ETF, but, since each purchase involves a commission and, on $100 purchases investors donÂ't get any real break, most experts agree that ETFs are not suitable for dollar cost averaging plans (unless the periodic investments were substantial).

Which of the following securities would most likely have the lowest expense ratio? A) Exchange-traded fund. B) Balanced mutual fund. C) Variable annuity. D) Hedge fund.

A) Exchange-traded fund. *Generally, most ETFs have a lower expense ratio than do comparable mutual funds. ETFs have other advantages over mutual funds in that they can be bought or sold at any time during the trading day (as opposed to end of day pricing), they can be bought on margin, and they can be sold short. Variable annuity expense ratios tend to be higher than mutual funds and those for hedge funds are the highest of all.

One type of specialized fund is referred to as a "country" fund. In most cases, these funds are closed-end investment management companies: A) so that their ADRs may trade on U.S. stock exchanges. B) because it is often difficult to liquidate the foreign securities to get their value into the U.S. C) in order to comply with the Geneva Convention. D) because of the ease of redemption.

B) because it is often difficult to liquidate the foreign securities to get their value into the U.S. There are a number of funds that invest exclusively (or predominately) in the shares of companies domiciled (and traded) in a single country. Not all securities markets are as liquid as those in the U.S. and many countries have currency restrictions limiting the amount of money that may be taken out of the country at any one time. Therefore, organizing as a mutual fund is not very practical. With no need to redeem share, closed-end companies are the obvious solution.

A customer has expressed interest in exchange-traded funds (ETFs) and wishes to discuss them with you. You could tell him all of the following EXCEPT: A) A share of an ETF represents an entire portfolio, or a specific selection, of securities. B) Real time quotes are available for ETFs. C) ETFs have a NAV, calculated at the end of the trading day, that serves as the trading price until the next NAV is calculated. D) Selling short and trading on margin are available transactions with ETFs.

C) ETFs have a NAV, calculated at the end of the trading day, that serves as the trading price until the next NAV is calculated. While a NAV can be calculated for an exchange-traded fund, the price is set by the market and changes throughout the trading day.

Which of the following statements correctly describe similarities between exchange-traded funds and closed-end investment companies? I. There are a limited number of outstanding shares. II. They are traded on registered stock exchanges. III. They trade at prices that are not dependent upon but close to their net asset value. IV. Investors pay commissions to purchase and liquidate their positions. A) I and IV. B) II and III. C) II and IV. D) I and III.

C) II and IV. Both exchange-traded funds and closed-end investment companies are traded on exchanges; therefore, investors pay a commission when purchasing and liquidating shares. Only closed-end investment companies have a limited number of shares. Closed-end funds may trade at significant premiums or discounts from their NAV, while ETFs rarely stray far from NAV.

Which of the following are characteristics of exchange-traded funds (ETFs)? They are redeemable securities. They are priced by supply and demand. They are designed to track an index. They try to diversify within a particular industry. A) I and III. B) I and IV. C) II and IV. D) II and III.

D) II and III. Exchange-traded funds have many similarities to closed-end investment companies. They are traded rather than redeemed and are typically designed to track a particular index, such as the S&P 500. However, even though the actual trading price is determined (as are all prices on an exchange) by supply and demand, the nature of ETFs is such that those prices rarely stray far from the NAV.

A client of yours has been investigating a particular mutual fund. She mentions that she saw a blurb on the Internet that the fund has had net redemptions over the past 6 months and asks you to explain how that might affect the fund's performance. You should explain that: I. this is a good thing because now, with less money to invest, the fund's adviser is able to be more selective. II. performance will probably suffer because the fund's adviser will have to sell positions prematurely in order to meet redemption requests. III. this would be a good time to buy because the supply of shares exceeds the demand. IV. many of the fund's expenses are relatively fixed so with fewer shares outstanding to share the cost, the expense ratio will probably increase. A) II and III. B) I and IV. C) I and III. D) II and IV.

When a fund has net redemptions, it means that less money is coming in than is going out. In order to meet those redemptions, the fund's manager will either have to sell securities that they planned to hold on to, or maintain more assets in cash (which generally will return less than other investments). As the number of outstanding shares is reduced, the fund's fixed expenses are borne by fewer shares leading to an increased expense ratio.

One of your clients has seen the value of the aggressive growth fund in her portfolio fall by over 70%. Which one of these actions might be appropriate for her IAR? A) stay in this fund hoping for a recovery. B) take advantage of the drop in value by purchasing additional shares at this lower price. C) switch to a more conservative fund in the same fund family. D) switch to a money market fund in the same fund family.

C) switch to a more conservative fund in the same fund family. This question calls for a subjective answer and one could actually argue on behalf of any of these. But, for purposes of the exam, it would be most appropriate to suggest to the client that the sale would generate a tax loss and that perhaps moving into a less aggressive fund would enable the client to recover some of the loss of value. Obviously, the switch should remain in the same fund family to take advantage of the NAV to NAV transfer, avoiding a new sales charge.