Lesson 4: Investment Companies

When comparing ETFs and closed-end funds, which two of the following statements are TRUE? I. ETFs typically trade at a deeper discount or higher premium from NAV II. Closed-end fund shares typically trade at a deeper discount or higher premium III. Closed-end funds typically experience more volatility then ETFs IV. ETFs typically experience more volatility than closed-end funds

) II and III Closed-end funds can commonly trade at a discount or premium of 10%- 20% of their NAV, while ETFs are normally trading within 1% of their NAV. There is much greater market volatility in the price of closed-end shares than in ETFs.

All of the following options are typically available to investors at the termination of a UIT EXCEPT A) Receive an in-kind distribution B) Receive proceeds in cash C) Rollover into a new series of the same trust D) Receive a return of the principal that was invested

) Receive a return of the principal that was invested At the termination of the trust, UIT investors will receive the value of their units, but not necessarily a full return of their principal. UITs may offer the option to roll over the proceeds into a new series of the same trust. Some UITs pay out an actual distribution of the trust securities at termination, which is called making an in-kind distribution.

When a registered rep shifts a customer from one mutual fund to a different fund with a similar investment objective, A) They are engaged in "switching", a sales practice violation. B) They are conducting an illegal activity, which may result in a suspension from the securities industry. C) They are helping the client to achieve stronger investment returns. D) They are performing normal account maintenance, which typically involves the reallocation of cash from one mutual fund to another.

) They are engaged in "switching", a sales practice violation. "Switching" occurs when a registered rep moves a customer from one mutual fund to another fund with a similar, or identical, investment objective. There is no benefit to the customer when this occurs, and is usually harmful.

Class B Share

-Back-end load = fee to sell -contingent deferred sales charge -no breakpoints

Class C Share

-Level Load = collect fee annually

When a redemption of mutual fund shares is requested, the fund must redeem shares within A) 3 business days of request B) 5 business days of request C) 48 hours of request D) 7 calendar days

7 calendar days A mutual fund is required to respond to a written request for redemption of mutual fund shares within 7 calendar days.

Letters of Intent (LOI)

A breakpoint discounts based on a commitment to invest a specified amount over a period of time term is usually 13 months -Can backdate up to 3 months

Load or Sales Charge

A fee to buy or sell Class A Share -Front-end load = fee to buy -Breakpoints Class B Share -Back-end load = fee to sell -contingent deferred sales charge -no breakpoints Class C Share -Level Load = collect fee annually Class No-Load -No-Load = no transaction fees

Rights of Accumulation

A reduced sales charge based on aggregated holdings (total investments) in related accounts -Aggregate with immediate family members (e.g., spouse and children) -Aggregate holdings in different accounts owned by the investor (brokerage, retirement, 529s)

Breakpoint

A reduced sales charge based on amount invested -The more you invest, the more they will reduce the sales charge -NAV stays the same -POP gets smaller...

Closed-end company investments share all of the following features EXCEPT A) Multiple classes of common shares B) May be purchased on margin C) Offer common, preferred, and debt securities D) A fixed number of shares issued

A) Multiple classes of common shares Closed-end companies issue a single share class only. They are permitted to issue preferred shares and debt securities in addition to common shares

An investor seeking broad market exposure, low operating expenses and low portfolio turnover may wish to consider a A) Stock index mutual fund B) Money market mutual fund C) US Government bond fund D) Tax-exempt mutual fund

A) Stock index mutual fund An investor who is seeking broad market exposure along with low operating expenses and low portfolio turnover would be best served considering a stock index mutual fund. The other options would not provide the same breadth of exposure to the investor

A letter of intent includes all of the following features EXCEPT A) The option for the mutual fund to discontinue the contract with 30 days prior notice B) A reduction in sales charges that is applicable from the first covered purchase C) A term of 13 months D) The option to include a prior purchase that was made up to 90 days before the contract was established

A) The option for the mutual fund to discontinue the contract with 30 days prior notice A letter of intent is a unilateral contract that can be canceled at any time by the customer, but cannot be canceled by the fund. If the contract is canceled, shares from an escrow account are redeemed to pay for the sales charge that would have applied without the letter of intent.

Which share class is most appropriate for an investor purchasing a large-cap growth equity fund? A. Class A B. Class B C. Class C D. Class D

A. Class A least expensive annual expense ratio

An investor with VTI shares held for over one year might receive each of the following distributions except? A. Interest B. Dividends C. Long-term capital gains D. Short-term capital gains

A. Interest...payable from bonds

An investor places an order to buy 100 shares of VTI. The shares will be sold at their A. NAV B POP C. Market Price

A. Market Price (+ commission intra-day)

Mutual funds may engage in which of the following activities?

A. Selling securities short b. buying securities on margin c. entering a joint trading account d. pursue a non-diversified investment objective Answer: D (disclose this in prospectus)

An ETF VTI investor would face which of these risks? A. Specific Risk B. Market Risk C. Credit Risk D. Interest Rate Risk

A. Specific Risk = No B. Market Risk = Yes C. Credit Risk = No D. Interest Rate Risk = No

Mutual Funds can invest in which of the following asset classes?

A. Stocks B. Bonds C. Money Market D. All of the Above ALL OF THE ABOVE

Which of the following products can be sold with a discounted fee? A. Mutual Funds B. ETFs C. IPOs D. Closed-end funds

A: Mutual Funds

Expense Ratio

Annual fee to run mutual fund Management Fees -Pays the fund's portfolio manager -typically a fund's largest expense 12b-1 fees -Pays for marketing & shareholder services Other Expenses -pays miscellaneous costs outside the 12b-1 fees

With regard to the costs of ownerships associated with ETFs as compared to closed-end funds, which of the following statements is TRUE? A) ETFs are more costly than closed-end funds if they are concentrated in commodities B) ETFs are typically less costly overall C) ETFs are typically more costly overall D) ETFs are more costly than closed-end funds if they are concentrated in equities

B) ETFs are typically less costly overall ETFs are usually lower cost investments than closed-end fund shares because they have a less active management style. Many model their portfolios to track indices.

A customer that invests in a unit investment trust owns A) Shares in a portfolio of securities that is actively managed B) Units in a fixed portfolio of securities C) Units in a portfolio of securities that is actively managed D) Shares in a fixed portfolio of securities

B) Units in a fixed portfolio of securities Customers who invest in unit investment trusts own units in a fixed portfolio of securities. This is considered an advantage to some investors because they know the securities held by the trust for the life of their investment.

The threshold to qualify for a sales charge discount on a mutual fund is $75,000. An investor places an order for $72,500 of this fund, and is not informed by the registered rep that he would be entitled to a sales charge discount if he invests an additional $2,500. This is an example of a A) Breakpoint B) Letter of intent C) Breakpoint sale D) Value investor

Breakpoint sale A "breakpoint sale" occurs when a registered rep does not disclose to the customer the opportunity to take advantage of a sales charge discount, or "breakpoint".

A fund that holds shares of the same companies as the S&P 100 index is most likely which of the following? I. an index mutual fund II. a closed-end company fund III. private equity fund IV. an ETF

C) I or IV Index funds construct their portfolios by buying and holding similar securities as the index they track. This is a common strategy for index mutual funds and ETFs. These investments then have lower management fees because of this passive management approach. Closed-end funds employ more active trading strategies. Private equity funds are organized to raise capital to invest in high growth potential business opportunities.

Which of the following funds subjects investors to a broad range of equity securities with the lowest management fees? A) A global stock mutual fund B) A diversified domestic closed-end fund C) S&P 500 Index ETF D) A DJIA Index ETF

C) S&P 500 Index ETF Index funds traditionally carry the lowest management fees since there is little active fund management. The S&P 500 offers a broader range of companies than the DJIA Index which includes just 30 industrial stocks

Investment Companies (Investment Co. Act of 1940)

Created 3 different types of investment companies 1.) Management Companies -Open end funds (mutual funds -Closed-End Funds 2.) Unit Investment Trusts (UITs) -Exchange-Traded funds (UIT ETFs) 3.) Face Amount Certificates (FAC)

Money market funds are most appropriate for investors who A) Are looking for tax deferred investments owing to their high tax bracket. B) Have no alternative investment choices available to them. C) Are willing to take high degrees of risk. D) Are seeking safety and stability in their investment portfolio.

D) Are seeking safety and stability in their investment portfolio. Money market funds are suitable for investors who are seeking safety and stability in their investment portfolio. These products will often provide a high degree of liquidity.

Asset allocation funds invest A) In two asset classes at a time B) in a single asset class at a time C) In cash and cash equivalents only D) In a combination of assets to help diversify their investments

D) In a combination of assets to help diversify their investments Asset allocation funds invest in a combination of asset classes, including stock, bonds, and cash equivalents. This blend of assets helps investors achieve diversification in their portfolio.

The NAV of a closed-end company share is calculated at $10 per share. In this case, A) The customer will sell shares for $10 if the order was placed before the close of business B) The customer will purchase shares for $10 if the order was placed before the close of business C) The customer will sell shares at the NAV of $10 plus the sales charge D) The customer may buy or sell shares at a price higher or lower than $10

D) The customer may buy or sell shares at a price higher or lower than $10 The calculation of NAV of a closed-end fund is NAV = Fund Asset - Fund Liabilities/number of outstanding shares. NAV serves primarily as a benchmark for share value. Shares are actually bought and sold by supply and demand through exchange trading. Their price may be higher or lower than the NAV.

An investor places an order for a no-load mutual fund. Which of the following fees would she expect to pay? A. Sales charge b. front-end load c. back-end load d. expense ratio

D. Expense ratio How frequently? Annually

Which of the following would not result in an investor receiving a discounted sales charge? A. Breakpoint b. Letter of Intent C. Rights of Accumulation D. Selling the Dividend

D. Selling the Dividend

Exchange-Traded Funds (ETFs)

ETFs track an underlying index Can be structured as open-end fund (mutual fund) Trade intra-day in the market Tracks an index, sector, or commodity (= 95% of ETFs are passive; 5% active) -VTI = total stock market ETF (broad equity) -BND = Total Bond Market ETF (broad bond) -TIP = Treasury Inflated Protected Securities ETF (All TIPS) -GLD = Gold Trust

Every year a mutual fund will examine its operating expenses as a function of the average dollar value of its assets under management. This item is published as the mutual funds' A) expense ratio B) POP C) NAV D) 12b-1 fee

Expense Ratio The expense ratio of a mutual fund, typically published annually, is derived by dividing its operating expenses by the average dollar value of its assets under management. These expenses are taken out of a fund's assets and consequently reduce the return to a fund's investors.

Class A Share

Front-end load = fee to buy -Breakpoints -In general, cheapest way to buy mutual fund shares and plan to hold for long period of time

The responsibility of the sponsor of a unit investment trust includes which of the following? I. Selection of the securities for the trust II. Organizing the formation of the trust III. Tax reporting for the trust IV. Recordkeeping for the trust

I and II The sponsor of a UIT organizes the trust and is responsible for the selection of the portfolio securities. The trustee handles administrative functions, including the recording keeping, accounting and tax reporting duties.

Which two statements correctly compare ETFs and closed-end funds? I. Both are investment company products II. Closed-end funds are investment company products; ETFs are not III. Both have a stable pool of capital IV. Closed-end funds have a stable pool of capital; ETFs offer shares continuously

I and III Closed-end funds are actually considered a type of ETF by some. These are both classified as closed-end investment companies because they have a stable pool of capital that is raised through their initial public offering.

Which two of the following are characteristics of closed-end companies and their shares? I. May be purchased on margin II. Issue multiple share classes III. May be purchased with stop or limit orders IV. Are redeemed by the fund

I and III Closed-end funds are traded on exchanges and may be purchased or sold with specified pricing terms through stop and limit orders. They may be purchased on margin, unlike open end company shares. They issue a single class of shares only, and they are not redeemed by the fund. Shareholders must sell their shares on exchanges to liquidate their positions.

Closed-end funds are subject to regulation by which of the following? I. The Securities Act of 1934 II. The Investment Company Act of 1940 III. The Investment Advisors Act of 1940

I, II, and III

How do ETFs differ from closed-end company shares? I. ETFs are typically higher cost investments II. ETFs are typically lower cost investments III. ETFs are typically more actively managed IV. ETFs are typically less actively managed

II and IV ETFs are often less costly to own than closed-end company shares because they employ a more passive fund management strategy. Their portfolios are often constructed to replicate a major index or other market benchmark and less actually managed.

An investor that holds units in a UIT needs to liquidate the units. These units will be I. Sold to another investor on an exchange II. Sold to the issuing trust III. Worth at least the price at which they were issued IV. Valued at the end of the business day of the transaction based on the assets held in the trust

II and IV Investors that liquidate their ownership in a UIT sell their units back to the issuing trust. The value of the units is determined at the end of the business day based on the current valuation of the securities held in the portfolio.

Investors who purchase the mutual fund will pay the NAV or POP?

Investors pay the Public Offer Price (POP) Public Offer Price = NAV/ (1 - sales charge)

The Prime Fund includes a 12b-1 fee. This fee A) Is included in all Investment Company portfolios B) Is paid by a mutual fund from fund liabilities C) Is a type of sales charge that may not exceed 8.5% D) Is used to cover shareholder service expenses

Is used to cover shareholder service expenses 12b-1 fees are annual fees imposed by a mutual fund. The 12b-1 fee is drawn out of fund assets to cover distribution expenses, as well as shareholder service expenses. Distribution expenses include fees paid for marketing and selling fund shares, as well as advertising and the printing of prospectuses. Shareholder services fees are paid to parties who will respond to investor queries and provide investors with information about their investments. Not all mutual funds charge 12b-1 fees.

Mutual Fund Costs & Fees

Load or sales charge (fee to buy or sell) Expense Ratio (annual fee to run fund)

Investors who sell the mutual fund will receive the NAV or POP?

NAV

Public Offer Price Calculation

POP = NAV/(1-Sales Charge)

Purchasing Mutual Funds

Purchase from fund family (e..g vanguard, fidelity, T. Rowe) -all shares are new shares (registered under '33) -no secondary market for these shares -sale price may include a sales charge -Sales charges can be reduced through: -breakpoints (reduced sales charge for large investments) -letters of intent (achieve a breakpoint over time - 13 months) -rights of accumulation (investor can use share appreciation reach a breakpoint)

The benefit investors receive for reinvestment of mutual fund dividend and capital gains distributions is A) Breakpoints B) Tax deferred growth C) Reduced sales charge on reinvestment D) Tax exempt growth

Reduced sales charge on reinvestment The opportunity to reinvest distributions from the securities held within a mutual fund is compounded earnings. Unless the shares are held in a qualified retirement plan, taxation will apply on the distributions, whether reinvested or taken in cash. Reinvestment of distributions is permitted at no sales charge.

When compared to the expenses associated with the purchase of mutual fund shares, the cost of investment in a UIT is A) Usually about the same B) More expensive C) Less expensive for large purchases only D) Substantially cheaper

Substantially Cheaper The sales charges for investing in UITs are substantially less than comparable mutual fund investments because of the fixed portfolio. There is no management fee.

All of the following statements regarding mutual fund breakpoints are true EXCEPT A) The breakpoint for a mutual fund purchase applies even if the fund purchase is made through a brokerage account at another broker dealer B) Breakpoints must be available for a mutual fund to charge the maximum allowable sales charge. C) The breakpoint schedule applies to fund purchases in different fund families D) Financial advisors are prohibited from encouraging a customer to make a purchase just below the point at which a breakpoint would apply

The breakpoint schedule applies to fund purchases in different fund families A mutual fund's breakpoint schedule applies only to purchases within a single fund family.

In which of the following ways are UIT units and mutual fund shares most similar? A) They both sell interests to investors through continuous primary offerings B) They are both created for a specified length of time C) They are both redeemed by their issuer when investors want liquidity D) Additional shares or units are readily available for purchase

They are both redeemed by their issuer when investors want liquidity Both shares of mutual funds and UIT units are redeemed by their issuer when investors want liquidity. They are redeemed at the NAV price calculated at the end of that business day. Additional units in a UIT are only available when other investors have redeemed their units, but mutual fund shares are continually available.

The document that initiates the formation of a unit investment trust is the A) S-1 Registration Statement B) Subscription Agreement C) Trust Indenture D) Organizational Charter

Trust Indenture

Unit Investment Trusts (UITs)

Unit Investment Trusts hold a fixed portfolio of bonds -sell shares or "units" to investors, typically in a one-time public offering Passively managed / supervised (no active trading) -A fixed portfolio of bonds (e.g., a tax-exempt fixed-income trust) -Or tracks an index (e.g, the SPY tracks the S&P 500) Distributes portfolio income to investors (no reinvestment into trust) On the trust's maturity date any remaining securities in the portfolio are liquidated and distributed to the investors

What do investment companies do?

pooled money from many investors and deploy it based on specific investment goals

In a unit investment trust, what party is primarily responsible for the selection of the securities held by the trust? A) Administrator B) Trustee C) Sponsor D) Investment advisors

sponsor