Unit 14

Which of the following best describes a 12b-1 fee?

A fee charged by some mutual funds to cover sales and distribution expenses A 12b-1 fee may be charged by mutual funds that do not charge the maximum permissible sales load. SEC Rule 12b-1 allows a mutual fund to serve as distributor of its own shares and charge a percentage of the average net assets for distribution and sales-related expenses.

An investor invests $25,000 into the KAPCO Balanced fund. It would be unlikely for this investor to be required to pay a CDSC when redeeming

Class A shares Class B shares are known for their back-end load. Class C shares usually only have one for 1 year; but, if the investor redeems within that period, there will be a CDSC. Class A shares do not carry a back-end load, except under conditions that are beyond the scope of this exam.

Hedge funds are issued by

limited partnerships Almost all hedge funds are issued as limited partnerships with the investment adviser (portfolio manager) having an investment in the fund.

ABC Investment Company shares are trading at $13.80 on a per-share basis. The net asset value per share is $12.00. Which of the following conclusions correctly defines the relationship between trading price and NAV?

The fund's shares are trading at a premium of 15% to the NAV. This is a closed-end investment company whose shares are trading at a premium. The premium is 15% relative to the underlying NAV ($1.80 ÷ $12.00). The market price, not the NAV of the fund's shares, is determined by supply and demand in the market. How do we know this is not a mutual fund? There are two ways. Mutual funds do not trade; there is no secondary market for them. Secondly, the sales charge is 13.8% ($1.80 ÷ $13.80) which is far above the maximum 8.5% allowed.

"An investment company with a low expense ratio and a portfolio that doesn't change," is a description of

a UIT The key to this is that the portfolio does not change. Unit investment trusts (UITs) are characterized by a fixed portfolio; once put together, it remains until maturity of the bonds or liquidation of the equities. Index funds and ETFs do change their portfolios from time to time as the composition of the underlying index changes.

Contingent Deferred Sales Charge (CDSC)

a back-end sales charge paid for Class B mutual fund shares within a specified period, and depends on the investor's holding period. All mutual fund share categories are investments in the same underlying portfolio, and all investors pay a share of the fund's expenses

The term private fund would apply to all of the following EXCEPT

a unit investment trust Unit investment trusts are one of the types of investment companies defined in the Investment Company Act of 1940. They register with the SEC prior to offering their units to the public. The other choices are all types of private funds.

As defined in the Investment Company Act, investment companies include

face-amount certificate companies, management companies, and unit investment trusts The act defines investment companies as being management companies, face-amount certificate companies, or unit investment trusts. Management companies are further categorized as being open-end or closed-end, diversified or nondiversified.

The Alpha-Gamma Mutual Fund reports a large number of their investors liquidating shares of the fund, so much so that the dollar amount of liquidations exceeds the incoming cash for new purchases. This would lead to a condition known as

net redemptions One of the main features of open-end investment management companies (mutual funds) is that there is a continuous offer of new shares and ready redemption of old ones. When redemptions exceed new purchases, the fund suffers from net redemptions.

One way in which open-end investment companies differ from closed-end investment companies is that an open-end investment company's shares

outstanding will vary in number at any point in time. Open-end investment companies are capitalized with a continuous offering of new shares. As a result, the number of shares outstanding is constantly changing. It is the closed-end company, traded in the secondary markets, whose share prices are based on supply and demand which causes them to be bought or sold at a premium or discount to the NAV.

In a mutual fund portfolio, you might find all of the following EXCEPT

short stock A mutual fund is generally prohibited by the Investment Company Act of 1940 from taking short stock positions. There are exceptions to this rule, such as in the case of hedge funds. Index options are permissible if they are consistent with the fund's stated objectives. Junk bonds or high-yield bonds are permissible in those high income funds that authorize such an investment. Some funds may use covered calls to generate income.

A customer wishes to invest $97,000 in the XYZ Growth Fund, which offers only Class A shares. If the fund has a breakpoint sales charge discount at the $100,000 investment level, the course of action least appropriate for an agent is to

simply place the order as instructed. If a customer places an order for an amount just below a breakpoint threshold, he should be informed of the breakpoint discount as well as the various methods by which he can achieve it.

A client investing $50,000 into the KAPCO Growth Fund would most likely be eligible for a breakpoint if purchasing

the Class A shares Breakpoints for quantity purchases are available on shares that carry a front-end load. Those are Class A shares. Class B shares have a back-end load, Class C shares are considered level load, and when one purchases shares of a closed-end company, commissions are charged, as would be on any stock purchase.

Disregarding any potential redemption or CDSC fees, an investor tendering shares of an open-end investment company for redemption will receive

the next computed net asset value When an investor redeems (or purchases) open-end investment company shares, the investor receives the next computed net asset value (NAV) of those shares. This is known as the forward pricing rule.

An investor is studying the prospectus received from the Abundant Returns Asset Allocation Fund. In a section titled Tenure, the discussion would be dealing with

the number of years the portfolio manager has been managing the fund Tenure always refers to management tenure, the length of time the portfolio manager has been at the helm of the fund.

Asset-based sales charges will generally be lowest when holding

Class A shares Class A shares have a front-end load, but a low- or no asset-based sales charge. Class B and C shares don't have a front-end load, but do have a higher asset-based sales charge. Class R shares invariably have a 12b-1 charge.

An investor has unexpectedly received $30,000 from an old debt he had written off. This money will come in handy for a business venture planned for 3 years from now. Meanwhile, he would like to generate some income on the money with as little risk and expense as possible. Which of the following recommendations is likely to be the most suitable for this customer?

Class C shares of the ABC Investment-Grade Bond Fund The customer wants income with as little risk as possible, so our answer must be one of the choices that offer an investment-grade bond fund. Of those offered, Class C shares would be best because the customer would pay no front-end sales charge and no CDSC after a short time, probably 1 year. He will pay somewhat higher 12b-1 fees than with Class A shares, but this will amount to only a fraction of 1% per year, and only for the 3 years of his investment.

Under the Investment Company Act of 1940, which of the following statements regarding the investment objective of a mutual fund are TRUE? Only the board of directors needs to approve changes in the investment objective. The majority of outstanding shares must vote to approve changes in the investment objective. The SEC must approve all changes in the investment objective. The investment adviser does not set, but tries to meet, the investment objective.

II and IV A majority of the outstanding shares must vote to approve any change in investment objective or policy. The investment adviser's job is to try to achieve the investment objective.

Starflier Mutual Fund, regulated under the Investment Company Act of 1940, wishes to change its investment policy. It may do so with approval of

a majority of the outstanding shares Changes in investment policy require a vote of the majority of outstanding shares for approval.

One way in which the method of capitalization of closed-end companies differs from that of open-end companies is that the closed-end company can

issue more than 1 class of stock Unlike open-end companies, which can only issue 1 class of stock (don't confuse this with different sales charge classes), closed-end companies can issue preferred stock. It is only the open-end company that continuously offers new shares, and both permit reinvestment of dividends. The fact that closed-end companies can be listed on an exchange is not a method of capitalization.

By investing in a REIT, you are provided all of the following EXCEPT

pass-through tax treatment of operating losses REITs cannot pass through losses to investors. It is important to remember that they are not DPPs.

One of your advisory clients meets the financial requirements for investing in a hedge fund. Having read so much about their outstanding performance, he asks you to describe any negatives to adding one to his portfolio. You could respond that

expenses tend to run very high diminishing the funds' performance One of the risks in investing in hedge funds is the very high overhead, largely in the form of management fees. The other choices here are all advantages of hedge funds.

If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as

a unit investment trust A unit investment trust issues shares that represent units of a particular portfolio; management has no authority, or only limited authority, to change the portfolio. The portfolio is fixed; it is not traded.

By investing in a REIT, you are provided all of the following except

flow-through tax treatment of operating losses. REITs do not offer flow-through of losses to investors. It is important to remember that the portion of the REIT's income that is distributed flows through; losses do not flow through. Although there are investments offering flow-through of both income and loss, such as DPPs, REITs are not one of them. Two of the benefits of investing in REITs are the professional management and the diversified real estate portfolio.

The Investment Company Act of 1940 allows a majority vote of outstanding shares of a registered investment company to authorize the fund to do all of the following EXCEPT

invest in securities consistent with the fund's objectives Shareholder approval is not necessary to authorize the fund to invest consistent with the fund's objectives; it is required as part of the contract with the fund's investment adviser. Under the Investment Company Act of 1940, a vote of the majority of outstanding shares may approve changing from an open-end to a closed-end company, changing the investment objectives of the fund, and deciding to cease to be an investment company.

The Investment Company Act of 1940 permits a reduction in sales charge when reaching a breakpoint for

purchasers meeting the definition of any person The term any person specifically excludes an investment club. Groups put together for the purpose of investing together, such as an investment club or clients of an investment adviser, do not qualify. Although there are exceptions, the exam will only consider accounts held for minor children as being included in the definition.

When comparing mutual funds and ETFs, the disadvantages of investing in ETFs include which of the following?

Commissions both when purchasing and liquidating shares Because the shares of ETFs are traded like any other stock, commissions are paid both to buy and to sell, and the price is determined by supply and demand, not NAV. ETFs are generally more tax efficient than mutual funds and their expense ratios tend to be lower as well.

A customer has been following several investment company quotes in the newspaper. She notices that the GEM Fund has an net asset value (NAV) of $12 and an ask price of $12.50, and that the ABC Fund has an NAV of $11.50 and an ask price of $10.98. The customer should conclude that

GEM may be an open- or closed-end fund and ABC is a closed-end fund The price for open-end funds is determined by adding the sales charge to the NAV. An open-end fund can never have an ask (or offering) price less than its NAV, therefore ABC cannot be an open-end fund.

Louis owns an investment that is an unmanaged portfolio in which the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the investment portfolio terminates. This statement best describes which type of investment?

Unit investment trust A unit investment trust (UIT) is a type of investment company whose units are sold in the secondary market and is generally unmanaged, or passively managed. The trust manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the UIT terminates.

A high net worth client expresses an interest in adding a hedge fund to her portfolio and asks for your advice. Among the points you could make is that

adding the hedge fund increases the portfolio's diversification Diversification is increased by adding asset classes or, in this case, a sub-class. When we are told that she is a high net worth client, it means she meets the eligibility requirements for purchasing a hedge fund. Although many hedge fund advisers are registered with the SEC, the funds are not. Hedge funds carry a number of risks, so we can't refer to them as low-risk investments.

The investment adviser under contract to a regulated, diversified, open-end investment company does NOT

change investment objectives that he believes are in the best interest of the investors The investment adviser is responsible for making investments according to the objective stipulated by the investment company. These decisions should maintain and reflect the diversified status of the fund and should identify the tax status of potential investments. The fund's objective may be changed only by majority vote of the outstanding shares (i.e., by the owners of the company, not the portfolio manager).

Examples of private funds include

hedge funds and private equity funds Private funds, such as hedge funds and private equity funds, are excluded from the definition of investment company under the Investment Company Act of 1940. As a result, they do not register with the SEC as do open-end and closed-end companies. Although these are generally sold as private placements under Regulation D of the Securities Act of 1933, there are many private placements that are not private funds.

The dollar amount of purchase at which sales charges are reduced in the purchase of open-end investment company shares is known as

the breakpoint Large purchases of investment company shares receive reduced sales charges at given minimums of investment. These are known as breakpoints.

All of the following are true of REITs EXCEPT

they must take equity or debt positions, never both Hybrid REITs take both equity and debt (mortgage) positions. REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to their shareholders. Although there has been an increase in non-traded REITS in recent years, unless the question specified them, assume they are publicly traded.

Which of the following statements concerning hedge funds are TRUE? Purchasers of hedge funds are generally required to be accredited investors. Short sales by the fund are not allowed. It is not uncommon for there to be a lock-up period that may last for as long one year or even longer. It would be unusual for the fund managers to have an ownership interest in the fund.

I and III Purchasers of hedge funds are usually required to be accredited investors. Hedge funds often have high liquidity risk due to the lock-up provision, which can restrict an investor's ability to liquidate the position. An advantage of hedge funds is their ability to sell securities short during bear markets, adopt risky arbitrage strategies, and otherwise take direct steps to maximize returns in both up and down markets. In almost all cases, the fund managers have a significant ownership position in the fund, or as the phrase goes, they have "skin in the game."

All of the following are characteristics of exchange-traded funds EXCEPT

they are redeemable securities Exchange-traded funds have many similarities to closed-end investment companies. They are traded based on supply and demand rather than redeemed and are typically designed to track a particular index, such as the S&P 500. In most cases, ETFs have lower operating expense ratios than mutual funds with similar objectives.

Ms. Foster is retiring in 2 years and will need income. Which of the following mutual fund types would most likely be the least desirable for her?

A special situation fund special situation mutual funds are risky and would not usually be considered suitable for a potential retiree.

Which of the following investment vehicles provides for redemption by the issuer?

Unit investment trust (UIT) A UIT typically issues redeemable securities (or "units"), like a mutual fund, which means that the UIT will buy back an investor's "units," at the investor's request, at their approximate net asset value. ETFs and CEFs are traded in the secondary markets and investors sell their shares in the marketplace rather than redeeming them through the issuer. Face amount certificates are not redeemable - the investor's funds are returned when the debt is paid off.

One way in which closed-end management investment companies differ from open-end investment management companies is that

they trade at a price independent of their net asset value Unlike open-end companies (mutual funds) where the price is based on the net asset value (NAV), closed-end companies trade at a market price based on supply and demand which could be above, below or the same as the NAV. Both are federal covered, both can have equity and debt in their portfolios (although only closed-end companies can issue senior securities) and both were in existence prior to passage of the Investment Company Act of 1940.

A pooled investment with a share price generally different from its net asset value (NAV) per share is most likely

a closed-end fund Closed-end funds' share prices can differ significantly from their NAVs. Open-end fund shares are purchased and redeemed based on their NAVs. Market forces keep exchange-traded fund share prices close to their NAVs because arbitrageurs can profit by trading when there are differences.

All of the following characteristics are advantages of a REIT EXCEPT

tax deferral A REIT is a professionally managed company that invests in a diversified portfolio of real estate holdings. REITs are traded on exchanges and OTC, which provides liquidity. The IRS does not permit tax deferrals on REIT investments. Please note: Over the past few years, there has been an enormous growth in non-traded REITs (they don't trade; there is no liquidity). However, there has been no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

When shares of a closed-end investment company are purchased by an investor, the price paid is based upon:

the current asking price Closed-end investment company shares are priced based on supply and demand. The ask is the price that investors will pay for purchasing shares, and the bid is what investors receive when selling. Investors will also pay a commission because this is what the broker charges for executing the transaction. Shares of open-end investment companies are bought and redeemed based on NAV, but that is not so of closed-end companies.

An investor reading the open-end investment company section of today's The Wall Street Journal sees that Bull in the Teashop Fund has a NAV of $10.65 and an offering price of $11.15. He knows that he would have received which of the following if his redemption order had been received by the fund prior to yesterday's market close?

$10.65, less redemption fee, if any An investor redeeming his shares will receive the NAV less any redemption fee that may be described in the prospectus. Investors redeeming through the fund are not charged a commission.

A client owning shares of a closed-end investment company entering an order to liquidate the position would receive a price based on

supply and demand for the shares. Closed-end investment company shares are traded in the same manner as any other corporate stock. That is, the price received when selling or the price paid when buying, is determined by supply and demand and has no direct relation to the net asset value. If this question was asking about an open-end investment company, the choice would be the next computed NAV, not offering price (that is the price when the investor is buying, not selling).

Which of the following would be the most important reason for an investor interested in adding foreign stocks to his portfolio to do so by purchasing an international mutual fund?

He would have the benefit of the portfolio managers picking the stocks instead of having to rely on his own efforts. There are two primary benefits to purchasing any mutual fund: professional management and diversification. However, an international fund has no domestic securities in the portfolio (that would be a global fund) so there would be no mix for diversification as indicated in that choice. There are no special tax breaks for investing in foreign securities via a mutual fund and the voting rights have nothing to do with the securities in the portfolio.

One reason that a private equity fund may operate under the Section 3(c)(7) exemption of the Investment Company Act of 1940 is that

it would be able to have more than 100 investors Private equity funds operate under two exemptions found in the Investment Company Act of 1940. The 3(c)(1) exemption limits the number of investors to 100 while no such limit applies to the 3(c)(7) exemption. Under the 3(c)(7) exemption, all investors must be qualified, a significantly higher standard than accredited. Investment advisers to private funds generally have to register and the selection of which exemption to use doesn't impact that. As private investments, liquidity is very limited.

Why are "country" funds organized as closed-end funds?

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 United States, 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 shares, closed-end companies are the obvious solution. Please Note. In recent years, things have changed, and a majority of country funds today are now open-end companies (mutual funds). We are urging NASAA to remove or revise any questions that deal with "old" information and will update our questions (and LEM) when they do.

Which of the following would be common features of mutual funds and hedge funds?

Investors have pooled their money together Both of these are in the category of pooled investment vehicles. Only the mutual fund is registered with the SEC and that means full disclosure, including portfolio holdings. No such disclosure is required of hedge funds. The mutual fund offers the 7-day redemption - no such policy exists with hedge funds. In fact, most have a lock-up period where redemption cannot take place.

When comparing exchange-traded funds (ETFs) to mutual funds, a feature available in ETFs that is NOT found in the mutual funds would include the ability to

be bought and sold at a profit the same day Unlike mutual fund shares, ETF shares can be traded on an intra-day basis. Mutual funds are generally only priced once per day, after the market closes, but, with an ETF, you can buy and then sell an hour or two later at a profit. They are similar in that they both represent an entire portfolio or basket of securities and both can have portfolios correlated to a specific index. Dividend reinvestment is available on ETFs and mutual funds, although the process tends to be more efficient with the funds.

One of your clients just inherited some money and wishes to invest $250,000 into the GEMCO International Equity Fund. The client is attracted to the Class B shares because there is no up-front sales charge on them while the Class A shares have a 3% front-end load. The appropriate response would be that

because of the higher 12b-1 charges levied against the Class B shares as well as the CDSC, Class A shares are recommended for a purchase of this size In the real world, there is probably no fund group that would accept a $250,000 order for Class B shares; more than likely, no fund group would even accept one above $100,000. That is because at that level, the reduced front-end load available on the Class A shares due to reaching a breakpoint, combined with the lower (or lack of) 12b-1 charge and no redemption charge (CDSC), makes them a better deal than the Class B shares. Rebating of commissions is not permitted, and even at the 4-year holding period, there still is a CDSC.

When discussing the differences between purchasing a mutual fund and a hedge fund, the investor should be aware that

hedge funds do not offer the transparency of mutual funds. Because hedge funds are not registered with the SEC (or the states), there are limited disclosures—the transparency is not nearly what investors have with mutual funds. Mutual fund investment managers always register with the SEC, and the same is true of must hedge fund managers, typically those with AUM of at least $150 million. Neither hedge funds nor mutual funds trade on listed exchanges and hedge funds do not have traditional share classes; they may offer a choice of different currencies, but that is totally different from the share classes of mutual funds.

Although investing in managed investment companies can provide many benefits, investors should be aware that disadvantages could include all of these EXCEPT

limited liquidity Open-end and closed-end are the 2 categories of managed investment companies. Liquidity is never a problem with open-end companies with the federal law requiring redemption at NAV within 7 days and, because almost all CEFs are traded on exchanges, they have a ready market as well. Management fees can be high and, because performance is due to the efforts of the portfolio managers, some just don't do very well. Finally, the investor has no say in when the fund elects to take gains or losses and that can have an impact on the investor's personal return.

In accordance with the stated provisions of the Investment Company Act of 1940, renewal of an open-end management investment company's investment adviser's contract must be approved by

majority vote of the fund's board of directors or of the outstanding voting shares, as well as by majority vote of the noninterested members of the board When it comes to management investment companies (open-end or closed-end), renewal of the investment adviser's contract is approved annually by the fund's board of directors or a majority vote of the outstanding voting shares. The initial contract must be approved by both the board of directors and a majority vote of the outstanding shares. In both of these cases, initial and renewal, a majority vote of the noninterested (outside) members of the fund's board of directors is also required.

Which of the following are TRUE of a REIT? It can qualify for special tax treatment under Subchapter M of the Internal Revenue Code if it distributes at least 90% of its taxable income. It may loan money for commercial construction projects. It generates income by the spread between rental income, the combined mortgage interest, and operating expenses of the property. It is only suitable for an investor who is in a 28% or higher tax bracket, who has a net worth in excess of $200,000, or who is able to benefit from the flow-through of losses.

I, II, and III A real estate investment trust (REIT) is an investment that makes direct investments in real estate, generating its income from renting the property (e.g., apartments, shopping malls) to lessees. Alternatively, it can make mortgage loans and generate income from them. Depending on its distribution of income, it may qualify for the same type of special tax treatment as a regulated investment company. REITS are not flow-through vehicles, as are DPPs.

Under the Investment Company Act of 1940, SEC Rule 12b-1 allows a fund to charge distribution and sales expenses to net assets as a percentage of the total assets. Normally, the cost of distribution of the shares is paid by the underwriter out of the sales load paid by the individual purchaser. For a fund to impose 12b-1 charges, which of the following conditions apply (applies)? The board of directors has sole approval authority. The majority of the outstanding shares has sole approval authority. Both the board and the majority of outstanding shares must approve it. A distribution plan must be written.

III and IV For the fund to impose 12b-1 charges, the distribution plan must be in writing and approved by a majority of the outstanding shares, as well as a majority of the board of directors, including a majority of directors classified as outside directors.

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

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 activities would have an effect on the NAV of a mutual fund? The sale of securities from the portfolio Automatic reinvestment of dividends by the shareholders Market appreciation of portfolio securities Market decline in the value of portfolio securities

III and IV The formula to determine NAV is: assets minus liabilities divided by shares outstanding. The sale of securities from the portfolio will replace the asset (securities) with an equal value of the asset (cash) and will have no effect on the NAV. The reinvestment of dividends will also not affect the NAV, because the shares going out are offset equally by the cash coming in. Market appreciation or decline will, however, affect the NAV because asset value will either increase or decrease, but liabilities and shares outstanding will remain unchanged.

A management investment company owns portfolio securities with a current market value of $100 million. The company owes $10 million for securities purchased but not yet paid for and accrued management fees of $5 million. If there are 2,611,437 shares outstanding and the current asking price of the shares is $36.38 per share, it would be correct to state that this investment company is

selling at a premium. When a closed-end investment company is selling at a price in excess of its net asset value, it is said to be selling at a premium. The net asset value per share of a management investment company (either open-end or closed-end) is computed by dividing the net assets (assets minus liabilities) by the number of outstanding shares. In this example, the assets are the $100 million portfolio value and the liabilities are $10 million for the unpaid securities plus the $5 million in accrued management fees. Subtracting the $15 million in liabilities from the $100 million in assets leaves $85 million. Divide that by the 2,611,437 shares outstanding, and the quotient is approximately $32.55. Once we know the NAV, it is clear that the price of $36.38 is a premium over the NAV. And, we know that this can't be an open-end investment company because if it was, the $3.83 sales charge represents 10.5% of the asking price ($3.83 ÷ $36.38), which is well in excess of the maximum 8.5% permitted.

An individual wishing to invest $15,000 into a mutual fund with the intent of having it remain invested for at least 15 years should probably purchase

Class B shares with a 12b-1 fee of .75% and a 6-year declining CDSC after which they convert to Class A shares. There are several keys to answering this question. First is recognizing this is an individual investor. Although Class I shares generally offer the best deal, that share class is sold only to institutional investors. Next, we see that the size of the investment is $15,000. That is too small to reach any significant breakpoint. Finally, the client intends to hold the investment for at least 15 years so the CDSC attached to the Class B shares becomes irrelevant. Because the Class B shares are sold without a front-end load, all of the investor's money goes to work. True, the 12b-1 charge is .50% higher than with the Class A shares, but that only lasts for the 6-year period until the B shares convert to A shares. That is a 3% difference over the 6 years, barely over half as much as the 5.5% front-end load. The Class C shares have no front-end load and the CDSC is unimportant here because it disappears after 1 year, but the 12b-1 fee never ends and, over a 15-year or longer period, that can remove the advantage the lack of a front-end load has to offer.

The offering document for a fund states that the minimum initial investment is $500,000. This is most likely what type of fund?

Hedge Hedge funds, due to their much higher risk, usually limit their investors to those who can afford to take that higher risk by having very high minimums. Do not be surprised if you see a test question referring to the hedge fund offering document as a prospectus. That is an acceptable term even though we tend to think of a prospectus referring to a registered issue (and hedge funds do not register with the SEC or the state).

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

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.

Which of the following are characteristics of a money market mutual fund? Shares are offered without a sales charge. There is a redemption fee. All purchasers must receive a copy of the prospectus. The letter of intent must be signed within 16 months.

I and III Money market funds are offered without sales loads or redemption fees. As with all mutual funds, a prospectus is required.

Which of the following may be done only with the approval of the shareholders of an investment company? A change from diversified to nondiversified status The purchase of particular bonds on the open market Personnel changes in the transfer agent's organization A change in the fund's objectives

I and IV Any substantive change in an investment company's form, structure, investment objective, or business operation must be approved by a majority vote of the outstanding shares. Bond purchases are left to the fund's portfolio manager, and the transfer agent is trusted with its organization's personnel changes.

A customer with an aggressive growth investment objective and short-term (6- to 12-month) time horizon wants to invest $50,000 in a mutual fund. He has a substantial net worth, but none of it is invested in mutual funds. You inform him that mutual fund investments are intended to be long-term investments, but he expresses his intention to make the short-term investment anyway. If the XYZ fund family (one you have dealt with in the past) offers an aggressive growth fund that has a respectable track record, your recommendation should be to

buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee If the client insists on making this type of investment, then the Class C shares are most appropriate for this customer's objectives; the sales load would be lower than that of either Class A or Class B shares. But, you ask, we don't know what the CDSC is for the Class B shares - it isn't given. It doesn't have to be because the CDSC for redemptions in the first year would never be lower than the Class A front-end load (4% in this question and certainly higher than the 1% on the Class C shares).

A client invests $2,200 in an open-end investment company and signs a letter of intent for a $10,000 breakpoint. If 6 months later he deposits $11,000, which of the following statements is TRUE?

He will receive a reduced load on $13,200 worth of the shares. An investor signing a letter of intent has 13 months to contribute funds to reach the reduced load. The sales charge in this case, then, will be based on the total investment of $13,200. If at the end of the 13 months the investor had not invested up to the breakpoint, the fund would liquidate enough shares to pay the difference in sales load.

When reading a research report about an investment company, you read that, in addition to common stock, the company also has a preferred stock issue outstanding. From this, you could conclude that this is

a closed-end investment company The only investment company that can legally issue preferred stock is a closed-end investment company. Open-end companies can only issue 1 class of stock (common stock or its equivalent). UITs issue units and term blended investment company makes no sense here.

Open- and closed-end investment companies have all of the following in common EXCEPT

they trade their shares in the secondary market Open-end companies do not trade shares in the secondary market. However, both open-end and closed-end companies compute their net asset values, actively manage their portfolios, and have stated investment objectives.

A mutual fund must redeem its tendered shares within how many days after receiving a request for their redemption?

7 days The 7-day redemption rule is required by the Investment Company Act of 1940.

All of the following may receive breakpoint discounts EXCEPT

an investment club Breakpoints are not available to investment clubs.

A hedge fund and a traditional mutual fund are similar in that

their portfolio managers are required to adhere to the fund's stated objective Both hedge funds and mutual funds have stated objectives. It is expected by owners that the management with follow those objectives. Only the hedge fund always has performance incentives and only the mutual fund has a low initial investment requirement. Mutual funds are prohibited from selling short.

A client wishing to invest $10,000 in a tax-exempt unit investment trust would be acquiring

units Unlike mutual funds in which the purchaser acquires shares, in a unit investment trust, the acquisition is of trust units

If XYZ Mutual Fund has an expense ratio of 1.85% that includes a 12b-1 fee of 0.30%, which of the following statements are TRUE? The fund may use the 12b-1 fee to pay for mailing sales literature. Advertising materials may state that the fund is no-load. Management fees may be paid from the 12b-1 fee. The fund's prospectus is required to disclose the fee.

I and IV 12b-1 fees may only be used to cover promotional expenses, not fund management expenses. The amount of the fee must be disclosed in the prospectus. Funds that charge 12b-1 fees of more than 0.25% cannot call themselves no-load funds.

If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as

a unit investment trust A unit investment trust issues shares that represent units of a particular portfolio; management has no authority, or only limited authority, to change the portfolio. The portfolio is fixed, it is not traded.

Which of the following is the least suitable mutual fund transaction?

Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence is not in the client's best interest, because the client might be subject to substantial additional sales charges.

Which of the following statements regarding investment companies is not true?

A management investment company can offer investors two ways of participating in the fund under management through the purchase of closed-end shares or, if the investor prefers, open-end redeemable shares. A management investment company cannot offer investors two ways of participating in the fund under management. The fund must either be a closed-end fund with shares traded in the marketplace or an open-end fund with redeemable shares. The Investment Company Act of 1940 classifies investment companies into 3 types: FACs, UITs, and management investment companies. Redemption (or purchase) of open-end investment company shares is based on the forward pricing rule. Because the offering of open-end investment shares is continuous, it is impractical to specify the exact number that will be issued.

Daniel has a number of investment company products within his retirement portfolio. One of these investments trades on an exchange, may trade at a premium or discount to its net asset value, and has a fixed capital structure. These features are most likely found in what type of investment?

Closed-end investment company A closed-end investment company (closed-end fund) is a type of investment company whose shares trade in the secondary market.

Which of the following statements correctly expresses requirements under the Investment Company Act of 1940?

No investment advisory contract may be entered into that does not provide for termination with no more than 60 days' notice in writing One of the provisions of the Investment Company Act of 1940 is that the maximum permitted termination notice is 60 days in writing. The custodial bank does not need FDIC coverage (this is not your local bank account) and the 3% limit is the maximum, not a minimum. In order to renew the advisory contract, it is either a majority of the funds directors or by a vote of a majority of the outstanding voting securities of the fund.

If a client who seeks diversification through real estate is concerned about illiquidity associated with investing in real estate, which of the following investments is most suitable?

Real estate investment trust Real estate investment trusts (REITs) are best suited to the client because they are market-traded securities that provide an investor with a liquid market in which to invest in real estate.

Why do some mutual funds offer Class A and Class B share options?

To give investors the option of choosing how they wish to be charged for the purchase of their funds Class A shares have a front-end load while Class B shares have a back-end load. The operating and administrative expenses are always higher on the Class B shares, but management fees are generally the same.

The exchange privilege offered by open-end investment companies allows investors to

exchange shares of one open-end fund for another in the same fund family at a net asset value basis Exchange privileges allow an investor to convert the value of shares held in one fund for those of an equal value in the same family. Remember that conversion is a taxable event; if the shares converted have increased in value, capital gains taxes will be due.

All of the following statements regarding a closed-end investment company are true EXCEPT

it may redeem its own shares A closed-end investment company does not redeem its own shares. The term mutual fund refers to an open-end management investment company that issues redeemable shares.