SIE Chapter 4

Bond funds

- US govt bond funds: Invest primarily in bonds issued by US govt; lower yield because safe - Corporate bond funds buy more diverse bonds, both low and high yield - High yield bond funds: invest in untested companies as well as well-known companies with bad credit, high yields and higher chance of default - Municipal bond funds (tax-exempt bond funds): interest income free from federal income taxes and possibly state and local, for HNW individuals in high tax brackets (capital gains still taxable)

12b-1 Fee

12b-1 fees are annual fees paid by mutual funds shareholders to cover the marketing and administrative expenses of the fund. 12b-1 fees do not cover management expenses or trading fees.

Unit Investment Trust (UIT)

A UIT is an investment company security that combines redeemable shares with a fixed portfolio. Specifically, the portfolio is assembled by a sponsor, who does not actively trade the portfolio. Not actively managed

Mutual Fund Custodian

A bank or trust company acts as custodian for mutual fund sand is responsible for the holding and safekeeping of the fund's securities and cash.

Breakpoint Sale

A breakpoint sale is a violation where a registered rep suggests than an investor purchases a mutual fund just below the point at which they would receive a discounted sales charge. For example, if there is a breakpoint at $250,000, suggesting the customer only invest

Letter of Intent (LOI)

A letter of intent allows a mutual fund shareholder to invest in installments and receive breakpoints, which are discounts off of A type of contract offered by a mutual fund in which an investor agrees in writing to purchase a specified amount of mutual fund shares over the next 13-month period. The sales charge applied on each purchase is based on the promised total investment

Municipal Bond Funds

A municipal bond fund, also referred to as a tax exempt bond fund, is a mutual fund consisting of tax-free municipal bonds. These funds are most appropriate for high-net-worth investors in high tax brackets who will most benefit from the tax-free nature of the interest income. When the fund pays out its net investment income to investors, the dividends are tax-free because they represent the tax-free interest income, though any capital gains distributions are taxable.

Rights of Accumulation

A privilege that allows mutual fund shareholders to receive sales charge discounts based on the current value of their investment in a fund or all funds in a family

Advantages and disadvantages of ETFs

A: One advantage of this passive strategy is that ETFs are typically a lower-cost option for investors because there are no management fees. ETFs have low portfolio turnover; creates greater tax efficiency, as realized capital gains are minimized, super liquid. D: Pay commissions, might lead investors to overtrade positions which is more risk and commission, lack of active professional management

Types of mutual funds

Actively managed funds: seeks to exceed average returns of market Index funds: Passively managed, limited trading activity

Advantages of UIT

An advantage of a fixed portfolio is that it allows investors to know what securities are held within a UIT through the life of the trust. There will be no "style drift" in the portfolio strat-egy. Investors will find the exact portfolio securities held by the UIT listed in its prospectus. The other benefit of this fixed portfolio is that UITs are often substantially cheaper than mutual fund shares because no fee for active management exists.

Management Investment Companies

An investment company, such as a mutual fund or closed end fund, that hires an investment adviser to actively select and manage a securities portfolio to achieve a stated investment goal

POP

An investor purchases shares of a mutual fund at the Public Offering Price ("POP"), which is equal to the NAV plus the sales charge per share

ETF Versus Mutual Fund Expenses

Because mutual funds are actively managed, they typically have higher fees for investors than ETFs.

Investment Company Comparison between ETFs, mutual funds, UIT

Continuous primary offering: Mutual funds Fixed number of shares issued through an IPO: ETF, UIT, closed end fund Redeemable shares at NAV: Mutual funds, UIT Actively managed: Mutual funds and closed end funds Fixed portfolio: UIT and ETF Stated termination date: UIT Distribution of dividends/capital gains: All

Cost Basis

Cost basis is the original value of an asset for tax purposes. If the asset is later sold for a profit, the difference between the cost basis and sales proceeds reflects the investor's taxable capital gain. Importantly, any dividends reinvested by an investor would increase their cost basis as the investor will have already paid tax on that income. For exampie, if an investor's original cost basis in a mutual fund is $1,000 and the investor receives $200 in dividends which they reinvest into the fund, their cost basis would be adjusted upwards to $1,200.

Selling points of mutual funds

Defined investment objective Professional Management Diversification Affordability Liquidity: Can be redeemed at any time for NAV plus redemption fees

How do mutual funds allow investors to earn money?

Dividend payments, capital gains distributions, NAV increases Investors pay tax on net investment income

Exchange-Traded Funds (ETFs)

ETFs are investment company securities that are designed to track a specific index or benchmark. Like closed-end funds, ETFs are exchange-traded and thus investors pay commissions when purchasing the shares.

Expense Ratio

Every mutual fund has an expense ra tio, which is the percentage of the fund's total assets that will be used to cover the expenses of the fund. It is calculated as (management fees plus operating expenses) divided by the average annual net assets of the fund. The fund's expense ratio would increase if the operating expenses of the fund were rising faster than the value of the fund's investments.

Transfer agent

Handles mutual fund transactions with customers 1. Issuing, redeeming, and cancelling fund shares 2. Handling distribution of dividend and capital gains to shareholders 3. Sending out trade confirmations

Index Funds

Index funds are mutual funds that seek to track the performance of a specific index - i.e. the S&P 500. Because they simply track an index and are not actively managed they have lower fees and expenses than other types of mutual funds. Generally, the only time the portfolio changes is when a company is added or subtracted from the benchmark index. For example, when Facebook was added to the S&P 500, all of the index funds that tracked the S&P 500 purchased Facebook stock. The process of updating the portfolio to continue to mirror the underlying index is referred to as reconstitution.

What does an investment adviser do for a mutual fund?

Invest cash and securities held for a fund's portfolio Implement the objectives outlined by the board Manage day-to-day trading of the portfolio

Money Market Fund

Money market funds are mutual funds consisting of money market securities, which are debt securities with maturities of one year or less. Because of the nature of the securities they invest in, money market funds are extremely safe and highly liquid. These funds generally attempt to maintain a stable NAV of $1.00 per share, though the price can fluctuate above or below that amount. Generally do not pay a sales charge (no load)

Mutual Fund Dividends

Mutual fund cash dividends are taxable for investors regardless of whether they are taken in cash or reinvested back into the fund.

ETFs Versus Mutual Funds

Mutual fund shares are redeemable, which means they can only be bought from and sold back to the mutual fund. There is no secondary market for mutual funds. In contrast, ETFs are exchange-traded and can be bought and sold between investors throughout the day. Because ETFs have a secondary market, they are considered more liquid than mutual funds.

Mutual Fund Shareholder Reports

Mutual funds are required to send financial reports to shareholders which include financial statements (e.g. a balance sheet and income statement) and detail the holdings of the fund's portfolio. These reports must be sent semiannually.

Fund Share Classes

Mutual funds can have different share classes. Class A shares have an upfront sales charge. Class B shares have a back-end load (aka contingent deferred sales charges or CDSCs), which investors pay when they redeem their shares. Class C shares have level loads. All share classes have 12b-1 fees, but Class Band C 12b-1 fees are usually higher than Class A shares. Class A shares are the only share class that can benefit from breakpoints.

Prohibited Mutual Fund Strategies

Mutual funds cannot sell stock short or borrow money.

Net Investment Income

Net investment income is the total profits that an individual earns from their investments. For mutual fund investments, this would include any dividends plus interest income plus net capital gains (capital gains minus capital losses).

No-Load Fund

No-load funds are mutual funds that do not charge a sales charge. They are purchased by investors at the NAV.

Open end fund characteristics

Number of outstanding shares: Constantly changing Securities issued: Common shares only Pricing: Forward pricing Purchasing shares: POP from the fund Sale of Shares: At NAV, redeemed by the fund Share class: A, B, C Expenses: Sales charges and 12b-1 charges Short selling/margin: Not allowed

Closed end fund characteristics

Number of outstanding shares: Fixed number Securities issued: Common, preferred, and debt securities Pricing: Continuous Purchasing/selling shares: At NAV or at a premium or discount to NAV depending on supply and demand Share class: One class Expenses: Only commissions for purchase/sale Short selling/margin: allowed

Breakpoint

Offer mutual fund investors discounts off of the sales charge based on dollar amount invested

Closed end vs open end funds

Open end funds: Share amount constantly changing, Share classes, only issue common shares, forward pricing, purchased at POP, sold at NAV, sales charges at 12b-1, no short selling or margin Closed end funds: Fixed number of shares, can short/purchase on margin, single share class, no 12b-1 fees, continuous market pricing, buy/sell based on supply and demand

Management fee

Percentage of fund's NAV

What does it mean for shares to be redeemable?

Redeemable shares are shares that a company has agreed it will, or may, redeem (in other words buy back) at some future date. The shareholder will still have the right to sell or transfer the shares subject to the articles of association or any shareholders' agreement.

Investment Company Act of 1940

Regulates these three entities: 1. Face amount certificate companies 2. Unit investment trusts 2. Management companies

Similarities and differences of closed end funds and mutual funds

Similarities: Both have the same advantages, like diversification, affordability, liquidity, and professional management and make distributions to investors, included capital gains and dividends Differences: Closed end funds have a fixed number of shares and are not redeemable. Only traded in IPO and secondary markets, do not need to maintain liquidity like mutual funds

lmpact of Dividends on NAV

The NAV of a mutual fund share will decrease by the amount of the dividend on the ex-date. This is because the fund is paying out cash so the fund's assets will fall.

Summary Prospectus

The SEC allows a mutual fund to deliver a summary prospectus to shareholders, which is a compilation of highlights from the longer prospectus. A summary prospectus includes the fund's investment objectives, fee structure, and other pertinent information. (performance history, tax info) It must be provided to investors prior to or at the time of sale. Financial reports must be sent semi annually

Structure of a UIT

The creation of a UIT involves the drafting of the trust indenture, by the fund's sponsor, which initiates the formation of the trust. In the indenture, the sponsor names a trustee to handle the administrative duties. UITs will have an established investment objective, and the securities they purchase are chosen to accomplish that objective. For example, the sponsor can build various types of fixed-income UITs, such as portfolios con-sisting of corporate, international, agency, and municipal bonds, as well as equity UITs, which can include a wide range of stocks.

reconstitiution

The process of adding or removing securities from the portfolio of an ETF or index fund to ensure that the portfolio mirrors the underlying index

Net Asset Value

The value of a mutual fund and the basis of what investors pay calculated as the total assets - total liabilities

Closed-End Fund & Pricing

Type of investment company that issues ETFs that represent actively managed portfolios Similar to mutual funds, closed-end funds have a net asset value, which is the total assets of the fund minus the total liabilities. However, because closed-end funds are exchange-traded, they can trade at a price either above or below their NAV based on the supply and demand of the shares.

Face amount certificate

Type of investment company that issues debt securities, backed by interest on real properties and securities

Mutual Fund & Investment Strategies

Type of management investment company that makes a continuous offering of brand new, redeemable (security directly bought back from and sold to issuer) shares to investors (open end fund) Mutual funds can invest in equities, corporate bonds and other registered securities.

Suitability of UIT

UITs offer an attractive opportunity for investors to own a portfolio of securities that is typically liquid with a low minimum investment. Because the portfolio is fixed, the cost of the investment is typically lower than that of other packaged products. Also, the absence of active trading in the portfolio creates great tax efficiency. There are almost no unexpected or unwanted capital gains distributions, except under unusual circumstances

Forward Pricing

When an investor purchases shares of a mutual fund, the price they pay is based on the next NAV (net asset value) calculation after the order is received. The NAV is calculated daily based on the closing price of the market. This is referred to as forward pricing. For example, if on Monday a customer places an order to buy shares at 5:00pm, which is after the market close, the price they would pay for the shares is based on Tuesday's closing price. The share price is not calculated based on the prior day's closing price or the next day's opening price.

Mutual Fund Suitability

When deciding on a mutual fund investme nt, the investor's investment objectives are the primary consideration. Fees are of secondary importance. Note that the size of the fund is typically the least important factor.

Risks of UIT

unit investment trusts may not be appropriate for investors seeking capital preservation. The portfolios take on the risk of the underlying securities. There is no assurance that an individual UIT portfolio will meet its objective. UITs are not actively managed and are not sold to take advantage of market conditions. Upon termination, there is no assurance that the value of the UIT will be equal to or higher than the original price. The level and type of risk associated with UITs may vary significantly from one trust to another. To know the risks, it is important to have a complete understanding of the under-lying securities from which a UIT derives its value. The investment strategies and risks of each UIT are fully outlined in the trust's prospectus.