Unit 3 Checkpoint Exam

All of the following are true of REITs except A)they must take equity or debt positions, never both. B)in most cases, their shares are publicly traded. C)they must invest at least 75% of their assets in real estate-related activities. D)they must distribute at least 90% of their net taxable income for favorable tax treatment.

A) 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 taxable 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.

A client wishing to invest $10,000 in a tax-exempt unit investment trust would be acquiring A)units. B)shares. C)bonds. D)participation interests.

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

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)a unit investment trust. B)a closed-end investment company. C)an open-end investment company. D)a blended investment company.

B)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 one class of stock (common stock or its equivalent). UITs issue units, and the term blended investment company refers to portfolio composition, not the fund's capitalization.

"An investment company with a low expense ratio and a portfolio that doesn't change" is a description of A)a no-load fund. B)an ETF. C)a UIT. D)an index fund.

C)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.

The term private fund would apply to all of the following except A)a venture capital fund. B)a hedge fund. C)a liquidity fund. D)a unit investment trust.

D) 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.

A mutual fund must redeem its tendered shares within how many days after receiving a request for their redemption? A)3 days B)7 days C)5 days D)10 days

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

When comparing mutual funds and ETFs, the disadvantages of investing in ETFs include which of the following? A)An expense ratio that is generally lower B)The ability to avoid tax consequences C)Commissions both when purchasing and liquidating shares D)A price not set by supply and demand

C) 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. Recently, a number of brokerage firms have begun offering commission-free trading for ETFs. That has not yet become the norm, so stick with our explanation until told otherwise.

By investing in a REIT, you are provided all of the following except A)pass-through tax treatment of operating losses. B)ownership of real property without management responsibilities. C)pass-through tax treatment of income. D)diversification of real estate investment capital.

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

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 A)she is probably not eligible to purchase a hedge fund. B)adding the hedge fund increases the portfolio's diversification. C)she should limit her purchase to a hedge fund that is registered with the SEC. D)hedge funds offer higher returns with less risk than similar investments.

B) 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.

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 A)reinvest dividend distributions. B)correlate to a specific index. C)represent an entire portfolio or basket of securities. D)be bought and sold at a profit the same day.

D) 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 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 or a loss. 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.

If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as A)a unit investment trust. B)a utilities fund. C)a growth fund. D)a closed-end company.

A) 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. Historically, UITs have had fixed bond portfolios, but in recent times, fixed equity portfolios are more popular.

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 A)be listed on an exchange. B)issue more than one class of stock. C)permit reinvestment of dividends. D)continuously offer additional shares.

B) issue more than one class of stock. Unlike open-end companies, which can only issue one 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.

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? A) Purchasing foreign stocks through a mutual fund saves on foreign taxation. B)He could select a fund whose portfolio had the proper mix of foreign and domestic stocks to maximize his diversification. C)The voting rights granted to a mutual fund shareholder are much stronger than those to the holder of an ADR. D)He would have the benefit of the portfolio managers picking the stocks instead of having to rely on his own efforts.

D) 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.

Examples of private funds include A)exchange-traded notes (ETNs) and private equity funds. B)open-end and closed-end investment companies. C)hedge funds and private equity funds. D)hedge funds and private placements.

C) 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 open-end and closed-end companies do. 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. Exchange-traded notes (ETNs), being traded on exchanges, are not private funds.

All of the following are characteristics of exchange-traded funds except A)they are redeemable securities. B)they generally have a lower expense ratio than comparable mutual funds. C)they are typically designed to track an index. D)they are priced by supply and demand continuously during the trading day.

A)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.

In a mutual fund portfolio, you might find all of the following except A)shares of common stock. B)junk bonds. C)2% of the outstanding voting securities of another registered investment company. D)short stock.

D) 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. Shares of common stock 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. A mutual fund is permitted to own up to 3% of the outstanding voting shares of another investment company.

All of the following characteristics are advantages of a REIT except A)diversification. B)tax deferral. C)professional management. D)liquidity.

B) 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 that over the past few years, there has been a growth in non-traded REITs (they don't trade; there is no liquidity). However, there has been no exam 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.

Hedge funds are issued by A)investment companies. B)portfolio advisers. C)Administrators. D)limited partnerships.

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

A hedge fund and a traditional mutual fund are similar in that A)both use long and short positions, swaps, and arbitrage. B)both typically have low initial investment requirements. C)both offer performance incentives to the fund manager. D)their portfolio managers are required to adhere to the fund's stated objective.

D 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 will 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.

Asset-based sales charges will generally be lowest when holding A)Class C shares. B)Class A shares. C)Class B shares. D)Class R shares.

B) 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 higher than that of Class A shares but lower than that of Class B and Class C shares.

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 A)the number of years the portfolio manager has been managing the fund. B)the average period of time the investors remain in the fund. C)the length of time that the fund has been in operation. D)the length of time that asset allocations are maintained before changes are made.

A) 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.

Although investing in managed investment companies can provide many benefits, investors should be aware that disadvantages could include all of these except A)unpredictability of tax consequences. B)poor management performance. C)limited liquidity. D)high expenses.

C) limited liquidity. Open-end and closed-end are the two categories of managed investment companies. Liquidity is never a problem with open-end companies with the federal law requiring redemption at NAV within seven 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.

As defined in the Investment Company Act, investment companies include A)diversified companies, nondiversified companies, and face-amount certificate companies. B)face-amount certificate companies, management companies, and unit investment trusts. C)mutual funds, closed-end companies, and unit investment trusts. D)open-end companies, closed-end companies, and unit investment trusts.

B) 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.

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 A)the compensation grid to the manager of a 3(c)(7) fund is higher than to a 3(c)(1) fund. B)it would be able to have more than 100 investors. C)greater liquidity would be assured. D)investors would only need to be accredited rather than qualified.

B) 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. The compensation to the manager of a private equity fund is not based on the exemption used.

Which of the following statements regarding investment companies is not true? A)When investors redeem their open-end fund shares, they receive the net asset value (NAV) per share next computed after the redemption order was received. B)The Investment Company Act of 1940 classifies investment companies into three types: face-amount certificate companies, unit investment trusts, and management investment companies. C)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. D)When an open-end investment company, or mutual fund, registers its offering with the SEC, it does not specify the exact number of shares it intends to issue.

C)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 three 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.

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 A)decline the transaction because short-term trading of funds is not allowed. B)buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee. C)buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee. D)buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee.

D) 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 because 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). Although short-term trading of mutual funds is generally considered unsuitable, there is nothing illegal about it.

Why do some mutual funds offer Class A and Class B share options? A)To give investors the option of purchasing shares prior to or after 4:00 pm ET B)Class A shares have lower management fees, while Class B shares have lower administrative costs C)To differentiate between those shares sold directly from the fund's principal underwriter and those sold by broker-dealers D)To give investors the option of choosing how they wish to be charged for the purchase of their funds

D)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.