Series 7 Unit 8

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 three years from now. Meanwhile, he would like to generate some income on the money with as little risk and as little expense as possible. Which of the following recommendations is likely to be the most suitable for this customer? A) Class A shares of the MNO High-Yield Bond Fund B) Class C shares of the ABC Investment-Grade Bond Fund C) Class B shares of the XYZ Growth Fund D) Class B shares of the ABC Investment-Grade Bond Fund

B

The practice of dollar cost averaging requires the investor to A) sell a security in a falling market and sell it in a rising market. B) sell a security in a falling market and buy it in a rising market. C) buy a security in a falling market and sell it in a rising market. D) buy a security in a falling market and buy it in a rising market.

D Dollar cost averaging requires the investor to invest a fixed amount of money on a regular basis, regardless of whether the stock market is rising or falling. When this is done, more shares are purchased when the price per share is low and fewer when the price per share is high. In following this scheme, the investor's average cost per share is lower than the average price paid per transaction. LO 8.e

If the value of securities held in a fund's portfolio increases, and the amount of liabilities stays the same, the fund's net assets A) stay the same. B) increase. C) decrease. D) are more liquid.

b An appreciation in value of fund assets, without a corresponding increase in liabilities, leads to an increase in the fund's net asset value (total assets minus liabilities equals net assets).

An investment company that holds which of the following does not meet the definition of a diversified investment company under the Investment Company Act of 1940? A) Eighty percent of its assets in securities of 50 health care companies B) Thirty-three percent of its assets in securities issued by a small-cap new issue C) Eight percent of a given corporation's voting stock in its portfolio D) Four percent of its assets invested in the stock of a major publicly held corporation

b An investment company that has invested 33% of its assets in any issue, small-cap or not, exceeds the limits set in the 75-5-10 test. This test requires that 75% of the assets be invested in securities issued by companies other than the investment company (regardless of the type of companies) so that no more than 5% of total assets are invested in any one company and no more than 10% of an outside corporation's voting securities are owned by the investment company.

Under the Conduct Rules, the maximum sales charge on any transaction involving an open-end investment company share is A) 9% of the offering price. B) 9% of the net asset value. C) 8.5% of the net asset value. D) 8.5% of the offering price.

d

An investor redeems 200 shares of ABC Fund, which has no redemption fee. If the quote is $12.05 bid $13.01 asked, what amount will the investor receive? A) $2,275.50 B) $1,098.00 C) $2,602.00 D) $2,410.00

d If a mutual fund has no redemption fee, the investor will receive the bid price per share (net asset value) multiplied by the number of shares being redeemed. In this case, the investor would receive $2,410 ($12.05 × 200 shares).

In July, a customer invested $10,000 in the ABC Mutual Fund. In December of the same year, ABC announced a long-term capital gains distribution. In May of the next year, the customer decided to redeem his shares for a capital gain. How are both of the capital gains treated for tax purposes? The capital gain distribution is treated as long term. The capital gain from redemption is treated as long term. The capital gain from redemption is treated as short term. The capital gain distribution is treated as short term.

1 AND 3 When long-term capital gains are distributed, the length of time an investor has owned the fund is not relevant; it's still a long-term distribution. However, redemption of shares follows the normal holding period rules. Therefore, when this customer sold shares 10 months (July to May) after the purchase, the gain, like any other gain from a holding period that does not exceed 12 months, is short term.

A unit investment trust has 90% of its portfolio invested in high-grade bonds with an average maturity of almost 25 years. If the industry consensus was that long-term interest rates were about to increase sharply, which of the following actions would most likely be taken? A) No action would be taken B) Liquidate and begin to move into cash or cash equivalents C) Switch to short-term bonds D) Ladder the maturities

A One of the key distinctions of a UIT is its lack of management. Once the portfolio has been created, it is fixed until maturity, in the case of debt securities, or until some predetermined liquidation point, in the case of an equity trust.

An investor purchased a 2x leveraged inverse ETF for $10,000. The ETF was linked to the performance of the S&P 500. During the first period, the S&P 500 rose by 8%, while during the next period, the index fell by 7%. What is the investment's value at the end of the second period? A) $9,576 B) $9,976 C) $10,044 D) $9,844

a The investment's value at the end of the second period would be $9,576. In 2x leveraged inverse ETF, the value of the shares would move in an opposite direction to an index by twice the amount of movement of the index. When the S&P 500 rose by 8%, the leveraged inverse ETF would have fallen by 16%. The investment value would have declined to $8,400 ($10,000 16% = $1,600; $10,000 - $1,600 = $8,400). When the S&P 500 fell by 7%, the leveraged inverse ETF would have increased by 14% from $8,400 to $9,576 ($8,400 14% = $1,176). $8,400 + $1,176 = $9,576.

All of the following must be sold with a prospectus except A) an IPO of common stock. B) closed-end funds in the primary market. C) closed-end funds in the secondary market. D) open-end funds in the primary market.

c Securities sold in the secondary market do not have a prospectus delivery requirement.

Under the conduit theory of taxation, which of the following statements are true? A fund is not taxed on earnings it distributes if it distributes at least 90% of its net investment income. Investors are not taxed on earnings they reinvest. A fund is only taxed on interest income. Investors are taxed on earnings they receive in cash. A) I and II B) I and IV C) III and IV D) II and III

B By qualifying as a regulated investment company (the conduit, or pipeline, tax theory), the fund is liable only for taxes on retained income if it distributes at least 90% of its net investment income to shareholders. Investors will pay taxes on distributed income, whether it is received in cash or reinvested

The practice of dollar cost averaging requires the investor to A) sell a security in a falling market and sell it in a rising market. B) sell a security in a falling market and buy it in a rising market. C) buy a security in a falling market and sell it in a rising market. D) buy a security in a falling market and buy it in a rising market.

d Dollar cost averaging requires the investor to invest a fixed amount of money on a regular basis, regardless of whether the stock market is rising or falling. When this is done, more shares are purchased when the price per share is low and fewer when the price per share is high. In following this scheme, the investor's average cost per share is lower than the average price paid per transaction.

An investment company registered under the Investment Company Act of 1940 that allows shareholders to sell their shares back to the company at the net asset value per share only at certain specified times is A) an open-end investment company. B) a closed-end investment company. C) a unit investment trust. D) an interval fund.

d The unique characteristic of an interval fund is that at certain specified intervals, shareholders are able to sell their shares back to the fund at NAV. True, these are closed-end investment companies, but on the exam, you always need to choose the most specific answer. Open-end investment companies (mutual funds) and unit investment trusts (UITs) permit redemption at NAV on a continuous basis, not at specified intervals.

All of the following are expenses to the operation of mutual funds except A) the legal costs of SEC filings. B) the custodian bank's charges. C) the fees paid to the fund's investment adviser. D) the compensation paid to the underwriter or distributo

d The underwriters receive their compensation from the sales charges. Investors pay those charges rather than the fund itself.

The performance of the XYZ Growth Fund has been in the top 1% of all funds in its category for the past 1-, 5-, and 10-year periods. Which of the following would be the biggest risk factor to an investor investing in this fund? A) Lack of diversification in the portfolio B) The manager's tenure is six months C) A dividend yield of less than 2% D) Past performance is no assurance of future results

B Although one cannot predict the future from the past, when a portfolio manager has consistently been ranked at the top, it is not considered a major risk to bet on a winner. The problem here is that almost all of that performance was achieved under the direction of previous management. With only six months on the job, the new manager is untested and there is no way to know how the future performance will rank. You might see this referred to as tenure risk. Diversification is one of the benefits, not risks, of a mutual fund. In a growth fund, one does not expect a high dividend yield.

Your client wishes to invest $50,000 into shares of the ACE Mutual Fund. This morning's financial news indicated that the POP for ACE was $10.86, while the NAV was $10 per share. The client's order is placed at 2:00 pm Eastern time. Based on this information, you could confirm to the client a purchase of A) 5,000 shares. B) nothing yet, as you must wait for the POP to be computed based on the day's close. C) more than 4,604.052 shares, but fewer than 5,000 shares. D) 4,604.052 shares.

B Mutual funds use forward pricing, so we never know what we'll be paying per share (if purchasing) or receiving per share (if redeeming) until the next calculated price.

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 three years from now. Meanwhile, he would like to generate some income on the money with as little risk and as little expense as possible. Which of the following recommendations is likely to be the most suitable for this customer? A) Class A shares of the MNO High-Yield Bond Fund B) Class C shares of the ABC Investment-Grade Bond Fund C) Class B shares of the XYZ Growth Fund D) Class B shares of the ABC Investment-Grade Bond Fund

B 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 one 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 three years of his investment.

A sophisticated client has expressed an interest in becoming more aggressive with their investment strategy. Her current portfolio consists of the following: $50,000 cash $200,000 in retirement accounts $100,000 in various individual stocks in different industries $100,000 in a balance fund She is willing to invest $25,000 for a minimum of 7 to 10 years and accepts that the investment can and will fluctuate in value over time. Which of the following investments would be the most appropriate? A) XYZ Value Equity Fund B) MNO High-Yield Bond Fund C) ABC Capital Appreciation Small-Cap Fund D) DEF Asset Allocation Fund

C For someone who is willing to take the risk and invest for the long haul, a small- or mid-cap growth fund would be appropriate.

Under the Investment Company Act of 1940, which of the following statements regarding the renewal provisions of an investment adviser's contract is not true? A) The renewal must be approved by either majority vote of the board or majority vote of the outstanding shares, as well as majority vote of the noninterested members of the board. B) The renewal must state the adviser's compensation. C) The renewal may be executed orally, provided it is done within two years of the initial contract. D) The contract must be terminable upon no more than 60 days' notice.

C When an investment company employs an outside investment advisory firm to manage its portfolio, the act requires a written contract setting forth the adviser's compensation. The contract is for two years initially and must be renewed annually thereafter. The contract must be initially approved by a majority vote of the outstanding shares and the noninterested members of the board of directors and annually renewed by either a majority vote of the board of directors or of the outstanding shares, as well as a majority vote of the noninterested members of the board. The contract must be terminable at any time, with a maximum of 60 days' notice and with no penalty, upon a majority vote of the board of directors or of the outstanding shares, and it must terminate automatically if assigned.

Which of the following investments would likely have a lock-up period? A) A principal-protected fund B) A target date fund C) A unit investment trust D) Class B shares

a Principal-protected funds guarantee that the investor's return will never be less than the original investment, less any sales load. In order to honor the guarantee, the investor must agree to maintain the investment for the guarantee period. If not, the guarantee will generally be void. In essence, this means the investment is "locked-up" for that period.

A young first-time investor wants to put $10,000 of savings in an investment that she wants to see grow over many years. She intends to add to it in small amounts whenever able. A balanced mutual fund and an equity growth fund are chosen. What would be the most suitable share class for this initial investment? A) D shares B) B shares C) C shares D) A shares

b B class shares have a back-end load (sales charge) only payable when the shares are redeemed, and those sales charges dissipate typically over the first five to seven years. Until they disappear completely, the investment is help beyond that time. This is why B shares are generally most suitable for smaller investments (where taking advantage of breakpoints would not be a factor) made with a longer investment time horizon such as this one.

A customer who seeks to supplement his retirement income and has a high risk tolerance would likely find which of the following securities most suitable? A) Municipal GOs B) Investment-grade bond funds C) High-yield bond funds D) Treasury receipts

c High-yield bonds yield more than investment-grade bonds. Because the client has a high risk tolerance, these bonds are more appropriate than investment-grade bonds with their lower yields. Unless something indicates a high tax bracket, the answer will not be municipal bonds, and Treasury receipts are low risk with no current income.

Which of the following would be considered improper by FINRA? A) A mutual fund distributor offering a member firm a free training seminar held at the distributor's home office for up to two representatives selected by the member firm. B) A member firm awarding a $1,000 cash bonus to any employee who, during the next month, sells at least $100,000 of the company's proprietary mutual fund C) A registered representative giving a $500 wedding gift to her brother who is one of her clients. D) A member firm awarding a $1,000 cash bonus to any employee who, during the next month, sells at least $100,000 of any mutual funds the firm has sales agreements with

B No compensation, especially in the form of a bonus, may be conditioned on the sale of a specific product. This is particularly egregious behavior when the product is proprietary. Paying a $1,000 bonus for reaching a sales goal is fine, as long as no specific product is targeted. Training seminars, even with all expenses paid by a fund distributor, are fine as long as the firm selects the attendees based on other considerations than sales of that distributor's funds and the location is appropriate. It would be hard for FINRA to fault this wedding gift to a brother in spite of the client relationship.

Mutual fund shareholders are often advised to enroll in automatic dividend reinvestment programs. In those programs, the investor can elect to have all distributions, or just those from income or just those from capital gains, automatically reinvested in additional shares of the fund. Among the advantages to the investor would be A) deferral of taxes until the shares are sold. B) automatic compounding of the investment. C) the additional shares are not subject to 12b-1 fees. D) the additional shares are purchased below the NAV.

B Similar in concept to the compounding of interest in a savings account, when distributions are reinvested rather than withdrawn, the capital has an opportunity to compound. Taxes are due in the year for which the distribution is paid (no tax break here). The shares are purchased at NAV; there are never cases where mutual fund shares are purchased below the NAV. If the fund has a 12b-1 charge, it would apply to the reinvested shares just as any other shares.

If a customer transfers his holdings from one fund to another within the same family of funds, what are the tax consequences? A) No gain or loss is recognized until redemption. B) Losses are deducted, and gains are deferred. C) On the transaction date, any gain or loss is recognized for tax purposes. D) Gains are taxed, and losses are deferred.

c An exchange is a taxable event. The cost basis of the shares in the original account must be compared to their redemption value. Any gain or loss is recognized in the year of the exchange. The exchange privilege allows the investor to avoid paying an additional sales charge. It does not allow the investor to avoid taxes.

If two customers wish to combine their purchases of a mutual fund to take advantage of the fund's breakpoints, you should advise them that they may A) not do so because they both have accounts with the same broker-dealer. B) do so, provided they have no business connection with the fund sponsor. C) not do so because two unrelated buyers may not receive a breakpoint. D) do so, provided they indicate the proportion that goes into each separate account.

c Two customers cannot combine their purchases to take advantage of a fund's breakpoints. Breakpoints are never allowed for investment clubs.