Series 7 Unit 8 (part 2)
Which of the following terms does not apply to municipal unit investment trusts (UITs)? A) Managed B) Registered C) Regulated D) Redeemable
A) Managed Municipal UITs buy bonds and hold them until redemption or call. The bonds are not actively traded, so the portfolio is not managed, but rather, overseen by a trustee. LO 8.a
Although investing in mutual funds has many advantages, there are some risks. One risk that is generally greater with a bond fund than a portfolio of individual bonds is A) interest rate risk. B) liquidity risk. C) purchasing power risk. D) default risk.
A) interest rate risk. One disadvantage a bond mutual fund has is that there is no maturity date. At maturity, a bond returns the principal, regardless of what current market interest rates are. LO 8.i
Dollar cost averaging (DCA) will always result in a lower cost per share than the price paid per share except A) when the price for each purchase is the same. B) when the price for each purchase is fluctuating.. C) when the price for each purchase is decreasing. D) when the price for each purchase is increasing.
A) when the price for each purchase is the same. There are two requirements for a dollar cost averaging program to work. The first is that the same amount must be invested at each specified interval. The second is that the price per transaction does not remain the same. If that is the case, then the average cost per share and average price paid per transaction are the same. The price needs to move for DCA to show a benefit. LO 8.e
If a registered representative is comparing two mutual funds for a customer, which of the following comparisons would not be permissible? A) Comparing diversified growth funds from two different fund families B) Comparing an equity growth fund to a money market fund, with the intention of convincing an investor to purchase the growth fund C) Comparing two equity funds with slightly different investment objectives, even if the differences and their consequences are carefully explained D) Comparing a long-term bond fund to a shorter-term bond fund to demonstrate the trade-offs that exist between risk and return.
B) Comparing an equity growth fund to a money market fund, with the intention of convincing an investor to purchase the growth fund A characteristic of money market funds is that they deliberately avoid growth. Thus, for the growth investor, comparing a money market fund to a growth fund is unfair. LO 8.g
Which of the following statements regarding mutual fund dividend distributions are true? I. The fund pays dividends from net investment income. II. A single taxpayer may exclude $100 worth of dividend income from taxes annually. III. An investor is liable for taxes on distributions, whether taken in cash or reinvested in the fund. IV. An investor is not liable for taxes if he automatically reinvests distributions.
B) I and III Mutual funds pay dividends from net investment income, and shareholders are liable for taxes on all distributions, whether reinvested or taken in cash. LO 8.f
The Investment Company Act of 1940 has two types of management investment companies—the closed-end and the open-end. Which of the following is a significant difference between the two? A) The closed-end investment company is generally more attractive for those investing small amounts. B) The closed-end company generally has a one-time offer of shares, while the open-end company's offer of shares is continuous. C) The closed-end investment company's portfolio can contain common stock, preferred stock, and bonds, while the open-end is limited to common stock only. D) Closed-end companies will never sell below net asset value per share, while open-end companies might if there are net redemptions.
B) The closed-end company generally has a one-time offer of shares, while the open-end company's offer of shares is continuous. Most of the differences between closed-end and open-end companies revolve around the different method of capitalization. That is, the one-time offer of shares on the part of the closed-end company is why the shares trade in the secondary markets, often at a discount to the NAV. LO 8.b
According to Municipal Securities Rulemaking Board (MSRB) rules, can a municipal securities representative give $50 crystal vases to 10 of his favorite clients? A) The representative is not allowed to give gifts to customers. B) Yes, he is permitted. C) He can, but only with written permission from the MSRB. D) No, the aggregate amount exceeds the permissible annual limit.
B) Yes, he is permitted. If each gift meets the $100 annual gift limitation, then they are permitted. LO 8.j
All of the following must register as an investment company under the Investment Company Act of 1940 except A) a new stock fund created by GHI Mutual Fund Distributors. B) an initial public offering for common shares of Amalgamated Investments, a holding company. C) certificates issued by a face amount certificate company. D) an initial public offering for shares of a closed-end management company.
B) an initial public offering for common shares of Amalgamated Investments, a holding company. Holding companies are not included in the definition of investment company under federal law. Amalgamated Investments would register with the SEC, just as any other offering of common stock. Investment companies, such as management companies (open-end or closed-end), unit investment trusts (UITs), and face amount certificate companies (FACs) all register under the Investment Company Act of 1940 as investment companies. LO 8.a
A registered representative notices that a fund he has been recommending to a recalcitrant customer has just declared a $1 per share dividend. Recognizing this as a great opportunity, he calls the client and explains that if a purchase is made within the next week, at the end of the month, the investor will receive a cash dividend of $1 for each share purchased. With a current public offering price of approximately $20 per share, that is a return on investment of 5% in a matter of a couple of weeks. This registered representative is A) properly showing the return as a percentage of the offering price. B) guilty of violating the practice of selling dividends. C) guilty of guaranteeing a dividend. D) offering the client a wonderful opportunity.
B) guilty of violating the practice of selling dividends. What the registered representative has not explained is that, upon payment of the dividend, the net asset value of each share will drop by $1.00. That is why the practice of selling dividends is prohibited. There is no problem with stating the dividend of $1 will be paid; that is not guaranteeing anything because the dividend has already been declared. Rate of return on a mutual fund should always be shown as a percentage of the offering price, but that "good deed" does not count when performing a misleading activity. LO 8.i
Which of the following investments is the most liquid? A) Common stock traded on the New York Stock Exchange B) Foreign stock mutual funds C) Money market mutual funds D) Variable annuities
C) Money market mutual funds LO 8.g
The primary asset in a tax-exempt bond fund would be A) common stock. B) short-term money market instruments. C) municipal bonds. D) corporate bonds.
C) municipal bonds. Bond funds will distribute taxable income or dividends unless invested in municipal bonds. Although dividend distributions from a municipal bond fund are tax exempt, capital gains distributions are fully taxable. LO 8.g
Your firm has just assigned you a new client. Wanting to do the best job you can, you review the current investment holdings of the client. Included are the following mutual fund accounts: $50,000 in Class B shares of the STU Growth Fund $25,000 in Class A shares of the STU International fund $15,000 in Class A shares of the TUV Utility Fund STU and TUV offer rights of accumulation and breakpoints at $25,000, $50,000, and $100,000. If the client wishes to invest $20,000 into the Class A shares of the STU Technology Fund, the sales charge would be based on A) the $50,000 breakpoint. B) the next computed net asset value. C) the $25,000 breakpoint. D) the $100,000 breakpoint.
C) the $25,000 breakpoint. There are several important points in this question. Rights of accumulation provide that a new purchase is added to the value of existing accounts to determine the breakpoint reached. However, only Class A shares count because the Class B shares never paid a front-end load. Of course, only shares in the same fund family are used - we cannot combine STU shares with TUV shares. As far as the math, we have $25,000 in one STU fund and are adding another $20,000. That brings the investor's account in STU funds to $45,000, which is enough to meet the $25,000 breakpoint, but not the breakpoint at $50,000. Finally, the sales charge is computed as a percentage of the public offering price (POP), not the NAV. LO 8.d
Net asset value (NAV) per share for a mutual fund can be expected to decrease if A) the securities in the portfolio have appreciated in value. B) the issuers of securities in the portfolio have made dividend distributions. C) the fund has made dividend distributions to shareholders. D) the fund has experienced a net redemption of shares.
C) the fund has made dividend distributions to shareholders. The NAV per share will rise or fall relative to the value of the underlying portfolio. If dividends are distributed to shareholders, the fund's assets decrease, and their per-share value will decline accordingly. Appreciation of the portfolio and dividends received will increase the value. Redemption of shares will have no impact on the NAV per share, as the money paid out is offset by a reduced number of shares outstanding. LO 8.c
Gerry Logan has been managing his own securities portfolio for the past 15 years. His returns have been about the same as the S&P 500, and as he gets older, he does not want to have to spend the time and effort to keep up the performance. Logan is currently 55 years old and has sufficient discretionary income and savings that enable him to take moderate risks. He is of the belief that his own experience proves that you can't beat the market. Which of the following would you suggest for him? A) 50% into an S&P 500 index fund (or ETF), 50% into an investment-grade bond fund B) 50% into an S&P 500 index fund (or ETF), 50% into a money market mutual fund C) 100% into an S&P 500 index fund (or ETF) D) 50% into an S&P 500 index fund (or ETF), 30% into an international index fund and 20% into an investment-grade bond fund
D) 50% into an S&P 500 index fund (or ETF), 30% into an international index fund and 20% into an investment-grade bond fund Index funds (or ETFs) are appropriate investment vehicles for investors who believe that active management does not produce returns above the cost. Investing in the S&P 500 would give him returns comparable to what he has enjoyed in the past. However, in recognition of his advancing age, it would appear prudent to diversify by placing some of the money into the international sphere and a portion into the safety of high-grade debt securities. LO 8.g
In order for an investment company to qualify as a regulated investment company (RIC), thereby avoiding triple taxation, it must act as a conduit (pipeline) and distribute a minimum of its net investment income (NII) to shareholders. At least what portion of the NII must be distributed? A) 50% B) 80% C) 89% D) 90%
D) 90% Under Subchapter M of the Internal Revenue Code (IRC), an investment company must distribute at least 90% of the NII to be classified as a RIC to avoid triple taxation. LO 8.f
Which of the following investment companies is limited to offering investors a single class of common stock representing ownership in the company? A) A closed-end management company B) A face amount certificate company C) A unit investment trust D) A mutual fund
D) A mutual fund LO 8.a
An investment company registered with the SEC under the Investment Company Act of 1940 that allows investors to sell their shares back to the company at net asset value on a quarterly basis is A) an open-end fund. B) a unit investment trust. C) a closed-end fund. D) an interval fund.
D) an interval fund. The unique feature of interval funds is that at certain intervals, which may be anything from monthly to annually, investors are allowed to sell a portion of their shares back to the fund at net asset value (NAV). LO 8.b
A stock mutual fund wishes to advertise itself as diversified. To be able to do so, the fund must invest its total assets, such that A) its portfolio consists of at least 15 different stock holdings B) no more than 5% of its assets in any one company. C) it holds no more than 10% of the voting stock of any one company. D) at least 75% of its assets meet stated diversification requirements.
D) at least 75% of its assets meet stated diversification requirements. The Investment Company Act of 1940 requires that a minimum of 75% of the assets of the diversified company meet stated requirements. Those requirements include the following: At least 75% of the fund's total assets must be invested in cash and securities that are not issued by the fund or any of its affiliates. Within that 75%, no more than 5% of the fund's total assets can be in a single stock. Within that 75%, no holding can represent more than 10% of the voting control of a single company. Please note that there are no restrictions on the nondiversified 25%. It can all be in a single stock. That means 30% of the fund's total assets can be in one company. Likewise, that 25% can be used to purchase a controlling interest in companies. LO 8.a
The Investment Company Act of 1940 describes several different classifications of investment companies. Two of those are the unit investment trust (UIT) and the open-end management investment company. In general, when referring to an open-end company, the subject is a mutual fund. One respect in which a unit investment trust (UIT) differs from a mutual fund is that A) the UIT requires initial capitalization of $1 million. B) investors in mutual funds may redeem their ownership interests. C) UITs do not compute net asset value (NAV). D) the portfolio is unmanaged.
D) the portfolio is unmanaged. The most significant distinguishing characteristic of a UIT compared with other investment companies is the lack of ongoing portfolio management. Once the initial portfolio is assembled, it remains fixed until the termination date. As with other investment companies, the minimum initial capitalization is $100,000. UITs, just as mutual funds, offer redeemable securities, and both types of investment companies compute their NAV. LO 8.a
Which of the following statements regarding exchange-traded funds (ETFs) are true? I. The SEC has classified them as mutual funds. II. The SEC has classified them as a type of open-end fund. III. They have operating costs and expenses that are higher than most mutual funds. IV. They have operating costs and expenses that are lower than most mutual funds.
II and IV The SEC has classified ETFs as a type of open-end fund but not a mutual fund. ETFs traditionally have operating costs and expenses that are lower than most mutual funds because they do not have to purchase and sell holdings within the portfolio to accommodate investors purchasing shares or redeeming shares, as is the case with mutual funds. LO 8.h
