Unit 10: Practice Exam 1 (Investment Company)

*An investment company share purchased at its NAV that can always be redeemed later at its then-current NAV is a:* A) Class C share. B) Class A share. C) Class B share. D) Class D share.

The correct answer was A. *Class A shares are purchased at NAV plus sales charge. Class B shares pay the sales charge upon redemption. Class D shares have a level load plus a redemption fee. Class C shares have only a level load (a 12b-1 fee) which is taken from net assets during the year.*

All of the following would qualify as management companies EXCEPT: face amount certificate companies. unit investment trusts. closed-end investment companies. open-end investment companies. A) I and II. B) I and III. C) II and IV. D) III and IV.

The correct answer was A. As defined in the Investment Company Act of 1940, closed- and open-end funds are subclassifications of management companies (actively managed portfolios). Face amount certificate companies and unit trusts are separate investment company classifications and do not have managed portfolios.

*A prospect has primary investment objectives of current income and safety of principal. During the initial public offering of a closed-end government bond fund, an agent explains to the prospect that the fund invests in U.S. government-backed bonds, which are very safe as to principal, and plans to make monthly distributions. Little could therefore go wrong. Taken as a whole, this representation is:* A) misleading because closed-end fund shares are subject to market pricing. B) accurate because the fund invests in government bonds. C) accurate because the fund offers current income. D) misleading because government bonds experience considerable credit risk.

The correct answer was A. Though parts of the agent's presentation are factually accurate, overall, the statements are misleading, because the value of the fund is subject to unpredictable change. Closed-end funds can, and often do, trade below their net asset value, thus subjecting the customer's principal to risk.

When comparing exchange-traded funds (ETFs) to mutual funds, some features available in ETFs that are NOT found in the mutual funds would include the ability to: correlate to a specific index. sell short. be bought and sold on margin. represent an entire portfolio, or basket of securities. A) II and III. B) I and II. C) I and IV. D) III and IV.

The correct answer was A. Unlike mutual fund shares, ETF shares can be traded on margin and sold short. 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.

A mutual fund's expense ratio is found by dividing its expenses by its: A) average annual net assets. B) public offering price. C) dividends. D) income.

Your answer, income., was incorrect. The correct answer was: average annual net assets. A mutual fund's expense ratio is calculated by dividing its expenses by its average annual net assets. Reference: 10.6.2.2 in the License Exam Manual.

***The POP for a mutual fund as quoted in the financial press reflects:*** A) the maximum sales charge the fund distributor collects. B) the average sales charge for the preceding 3 months. C) the minimum sales charge the fund distributor collects. D) no sales charge because the offering price depends on the quantity purchased.

The correct answer was A. The public offering price for a quoted mutual fund includes the maximum sales charge the fund distributor can assess.

A customer has been following several investment company quotes in the newspaper. She notices that the GEM Fund has an NAV of $12 and a POP of $12.50, and that the ABC Fund has an NAV of $11.50 and a POP of $10.98. The customer should conclude that: A) ABC and GEM are both unit investment trusts. B) ABC is an open-end fund and GEM is a closed-end fund. C) GEM may be an open- or closed-end fund and ABC is a closed-end fund. D) both are open-end funds.

Your answer, GEM may be an open- or closed-end fund and ABC is a closed-end fund., was correct!. The price for open-end funds is determined by adding the sales charge to the NAV. An open-end fund can never have a POP less than its NAV, therefore ABC cannot be an open-end fund. Reference: 10.7.4 in the License Exam Manual.

A mutual fund has a net asset value (NAV) of $7.80 per share, and the fund pays its underwriter a concession of $0.12 per share. If the fund has a sales load of $0.50 per share and an administrative fee of $0.15 per share, how much does the investor pay per share to purchase a Class A share of this fund? A) 8.3. B) 8.42. C) 8.57. D) 7.8.

Your answer, 7.8., was incorrect. The correct answer was: 8.3. The investor pays the public offering price (POP) when purchasing mutual fund shares. For a Class A share upon purchase, the POP is the NAV plus the sales charge. Reference: 10.7.4.6 in the License Exam Manual.

***A board of directors member for a mutual fund must serve a minimum term of:**** A) 1 year. B) 2 years. C) 3 months. D) 6 months.

The correct answer was A. Mutual fund board of directors members must serve a term of at least 1 year, and cannot serve more than 5 years without being reelected.

***All of the following describe the price of a no-load mutual fund EXCEPT:*** A) POP. B) NAV. C) bid. D) book value.

The correct answer was A. No-load open-end investment company shares are sold to investors and redeemed through the issuer at their book value, which is the same as their net asset value, or bid price.

Which of the following funds is most likely to contain within its portfolio securities of issuers who have NOT specified the use of the capital they are raising? A) Hedge fund containing blank-check and blind-pool offerings in its portfolio B) Income fund offered by an investment company registered under the 1940 Investment Company Act C) Exchange-traded growth fund D) No-load fund offered by a no-load mutual fund company

Your answer, Hedge fund containing blank-check and blind-pool offerings in its portfolio, was correct!. Blank-check and blind-pool securities are offerings where the issuer has not specified the use of the capital it is raising. While these securities are available individually to investors, some hedge funds will either target them or include them within their portfolios. The unique risks of these companies, coupled with the unique risks of hedge funds in general, must be considered in terms of suitability. Reference: 10.11.2 in the License Exam Manual.

A mutual fund must, at a minimum, provide which of the following periodic reports to shareholders? Audited annual reports. Unaudited annual reports. Audited semiannual reports. Unaudited semiannual reports. A) I and IV. B) II and IV. C) II and III. D) I and III.

Your answer, I and IV., was correct!. An investment company must send an unaudited report to shareholders at least semiannually and an audited report of its financial condition at least annually. Reference: 10.4.2 in the License Exam Manual.

All of the following statements regarding money market funds are true EXCEPT: A) specified rates are guaranteed. B) investors pay a management fee. C) dividends accrue daily. D) investors can buy and sell shares quickly and easily.

The correct answer was A. Interest on money market instruments is not guaranteed or specified. Money market funds are typically no-load funds with no redemption fee, but investors do pay a management fee. The dividends earned on an investor's shares are accrued daily.

*Which of the following are functions of an investment company's custodian bank?* Safekeeping of portfolio securities and cash. Providing portfolio advice regarding transactions. Maintaining asset records for the fund. Safekeeping of customer securities. A) I and III. B) I and IV. C) II and III. D) II and IV.

The correct answer was A. The custodian bank performs bookkeeping and clerical functions and retains the fund's cash and securities for safekeeping. The adviser offers portfolio advice and management services. The custodian provides for safekeeping of fund securities, not investors' securities.

***XYZ Technology Fund permits rights of accumulation. A shareholder has invested $9,000 and signed a letter of intent for a $15,000 investment. If his reinvested dividends during the 13 months total $720, how much money must he contribute to fulfill the letter of intent?*** A) 6000. B) 5280. C) 9000. D) 15000.

The correct answer was A. The shareholder must contribute the full $15,000, so he owes an additional $6,000. *Reinvested dividends and changes in the NAV do not count toward a breakpoint during the period of a letter of intent.*

If a registered representative is comparing two mutual funds for a customer, which of the following comparisons would NOT be permissible? A) Comparing diversified growth funds from two different fund families. B) Comparing two equity funds with slightly different investment objectives, even if the differences and their consequences are carefully explained. C) Comparing a long-term bond fund to a shorter-term bond fund to demonstrate the trade-offs that exist between risk and return. D) Comparing an equity growth fund to a money market fund with the intention of convincing an investor to purchase the growth fund.

Your answer, Comparing an equity growth fund to a money market fund with the intention of convincing an investor to purchase the growth fund., was correct!. A characteristic of money market funds is that they deliberately avoid growth. Thus, for the growth investor, a comparison of a money market fund to a growth fund is an unfair comparison. Reference: 10.6 in the License Exam Manual.

***To qualify for the quantity discount, which of the following may NOT be joined together under the definition of "any person" ?*** A) Father and his 35-year-old son investing in separate accounts. B) Husband and wife investing in a joint account. C) Father and son in an UTMA account. D) Trust officer working on behalf of a single trust account.

The correct answer was A. For the purpose of qualifying for breakpoints, the definition of "any person" includes family units, but only minor children. Adults, other than a husband and wife, are separate persons.

*Which of the following is the least suitable mutual fund transaction?* A) Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence. B) Encouraging an investor in a high-tax bracket with an income objective to invest in a municipal bond fund. C) Encouraging an investor in his early 30s to invest in an emerging markets mutual fund. D) Encouraging a retired 65-year-old investor to invest a small percentage of his savings in a large-cap growth fund.

Your answer, Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence., was correct!. 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, as the client might be subject to substantial additional sales charges. Reference: 10.7.4.4 in the License Exam Manual.

Potential investment company clients should be advised to investigate a fund by looking at which of the following? Investment policy. Number of shares outstanding. Custodian bank. Portfolio. A) I and IV. B) I and III. C) II and III. D) II and IV.

Your answer, I and IV., was correct!. Investment policy, track record, portfolio, and sales load should all be researched when assessing a fund. The identity of the custodian bank for the fund, or number of shares outstanding, does not bear on its performance or suitability. Reference: 10.6 in the License Exam Manual.

***A mutual fund's unrealized loss last month results in which of the following?*** Lower NAV per share. Lower dividend payments to shareholders. Reduction in the proceeds payable to shareholders who liquidate their shares. Higher tax liability to shareholders. A) I and III. B) I and IV. C) II and III. D) II and IV.

The correct answer was A. An unrealized loss is the same as a decrease in net asset value. An investor receives less at redemption than she would have received if the redemption had taken place before the asset's depreciation.

All of the following statements regarding a closed-end investment company are true EXCEPT: A) it sells at the market price plus a commission. B) it differs from a mutual fund. C) it may redeem its own shares. D) it is a type of management company.

Your answer, it may redeem its own shares., was correct!. 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. Reference: 10.1.1.3.1 in the License Exam Manual.

Which of the following statements describe characteristics of open-end investment companies? Shares are redeemable at net asset value. Shares are always sold by prospectus. Only a limited number of shares are offered. Shares are sold on securities exchanges. A) II and III. B) III and IV. C) I and II. D) I and III.

Your answer, I and II., was correct!. Open-end investment companies must be prepared to redeem shares at net asset value and open-end investment companies continually issue new shares that are sold by prospectus. Unlike open-end investment companies, closed-end investment companies issue a limited number of shares which then trade in the secondary market. Reference: 10.1.1.3.2 in the License Exam Manual.

*Investment clubs:* can take advantage of breakpoints on mutual fund purchases. cannot take advantage of breakpoints on mutual fund purchases. are permitted to purchase new equity issues at the POP. are not permitted to purchase new equity issues at the POP. A) II and III. B) I and III. C) I and IV. D) II and IV.

The correct answer was A. Investment clubs are not considered restricted persons under the rules regarding sales of a new issue, and therefore are eligible to purchase new equity issues. Note that if a registered representative (a restricted person) were a member of an investment club, the club would be prohibited from buying a new equity issue. Investment clubs are never permitted to take advantage of breakpoints available on mutual fund purchases.

If a customer purchases shares in a municipal bond fund, which of the following statements are TRUE? Dividends are taxable. Dividends are not taxable. Capital gains distributions are taxable. Capital gains distributions are not taxable. A) II and IV. B) I and III. C) II and III. D) I and IV.

Your answer, II and III., was correct!. Municipal bond funds distribute federally tax-free dividends, but any capital gain distribution is subject to taxation. The tax preferential treatment of municipal bonds is limited to the interest income earned, not the gains. Reference: 10.5.1.4.1 in the License Exam Manual.

*All of the following could be a redeemable security under the Investment Company Act of 1940 EXCEPT a(n):* A) security sold on an exchange at the market price buyers and sellers have established. B) security that pays out each investor's proportionate share of the company's assets. C) investment company security sold as a continuous initial public offering. D) security issued by an open-end investment company.

The correct answer was A. A redeemable security is purchased from and redeemed by the security's issuer. A security that can be traded on a secondary market is not redeemable. Open-end shares are redeemable securities, closed-end shares are not.

*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. A) I and IV. B) I and III. C) II and III. D) II and IV.

The correct answer was A. 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.

*All of the following events will affect the NAV per share of a mutual fund EXCEPT:* A) Wholesale redemption of fund shares . B) Changes in the market value of the fund's portfolio of securities . C) The fund receives cash dividends on the securities in its portfolio . D) The fund pays dividends to its shareholders.

The correct answer was A. Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. While share redemption will reduce total net asset value, the number of shares outstanding decreases in proportion, so the NAV per share stays the same.

The capital structure of an open-end investment company can include: A) one issue of common stock and limited bank borrowing. B) preferred and common stock with no bank borrowing allowed. C) only debt issues with no bank borrowing allowed. D) preferred stock, common stock, and bonds.

The correct answer was A. Open-end investment companies may only issue redeemable common stock. Preferred stock, bonds, and other forms of senior securities are not allowed. Bank borrowing is allowed subject to certain limitations.

A client invests $2,200 in an open-end investment company and signs a letter of intent for a $10,000 breakpoint. If he deposits $11,000 6 months later, which of the following statements is TRUE? A) He will receive a reduced load on $13,200 worth of the shares. B) He will receive a reduced load on $8,800 worth of the shares. C) He will receive a reduced load on $10,000 worth of the shares. D) He will not receive any reduction in the sales load.

Your answer, He will receive a reduced load on $13,200 worth of the shares., was correct!. 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. Reference: 10.7.5.1.1 in the License Exam Manual.

A customer is considering an investment in a hedge fund noting he has heard much about their high yield potential from a business acquaintance. In a discussion with him about these types of funds which of the following statements is TRUE? A) Hedge funds tend to be more suitable for many different customer profiles while mutual funds are generally more suitable for high net worth sophisticated investors only. B) Hedge funds often use higher degrees of leverage and more sophisticated investment strategies than mutual funds. C) Mutual funds are subject to less regulatory oversight than hedge funds. D) Mutual funds pool investors' money and manage the entire portfolio with a single objective, whereas hedge funds manage each investor's assets separately to meet their individual investment objectives.

Your answer, Hedge funds often use higher degrees of leverage and more sophisticated investment strategies than mutual funds., was correct!. Hedge funds utilize aggressive investment strategies not limited to selling securities short, and purchasing on margin. Often hedge funds have minimum initial investment requirements and lock-up provisions making withdrawals impossible for a period of time. These qualities of hedge funds make them less suitable for all investors and more suitable for high net worth and income (sophisticated) investors. Both mutual funds and hedge funds pool investors' money to manage a single portfolio of assets. Hedge funds are unregulated while mutual funds are regulated under the Investment Company Act of 1940. Reference: 10.11 in the License Exam Manual.

Holding Company Depository Receipts (HOLDRs) are traded on exchanges in round lots redeemable by the issuer, just as mutual funds shares are redeemable by an investment company investments that will distribute the cash dividends of the companies held in the portfolio directly to the investor investments that allow no flexibility in managing the tax consequences related to holding shares of the companies within the portfolio A) II and IV B) II and III C) I and IV D) I and III

Your answer, I and IV, was incorrect. The correct answer was: I and III HOLDRs are exchange-traded investments and trade in round lots (100 shares). They are not redeemable by their issuer like mutual fund shares are. Additionally, HOLDRs distribute cash dividends generated by the companies held in the portfolio directly to the owners of the HOLDR shares. These exchange-traded products allow great flexibility in managing the tax consequences of the investment because the securities can be unbundled and traded individually, thus taking loses when advantageous and deferring gains when advantageous. Reference: 10.12.1 in the License Exam Manual.

*Which of the following statements best describes a breakpoint sale?* A) Sale of investment company shares in dollar amounts slightly below the point at which the sales charge is reduced on quantity transactions, to make a higher commission. B) Sale of investment company shares in anticipation of a distribution scheduled to be paid shortly. C) Sale of investment company shares in dollar amounts above the point at which the sales charge is reduced. D) Compensation generated by commissions from a client who has reached another breakpoint, paid to the registered representative after he no longer works for the member.

Your answer, Sale of investment company shares in dollar amounts slightly below the point at which the sales charge is reduced on quantity transactions, to make a higher commission., was correct!. A breakpoint sale is a violation of the Conduct Rules. It occurs when a broker permits a client to purchase shares in an amount immediately below the amount that would qualify the client for a discounted sales charge, without informing him of the breakpoint. Reference: 10.7.5.1.2 in the License Exam Manual.

The prospectus of the ABC Fund contains the phrase "will have at least one-quarter of common stock investments in the field of business machines." The ABC Fund is: A) a balanced fund. B) a diversified fund. C) a specialized fund. D) a growth and income fund.

Your answer, a specialized fund., was correct!. A fund that, as part of its investment policy, makes a commitment to invest 25% or more of its assets into a particular economic or geographical sector is a specialized fund. A balanced fund invests in a balance of bonds and common and preferred stocks. A diversified fund does not invest more than 5% of the fund's assets in any one issuer. A growth and income fund may invest in many industries, seeking both dividends and capital gains. Reference: 10.5.1.1.4 in the License Exam Manual.

*If an investor has received dividends and capital gains distributions on mutual fund shares she has held for 4 months, the investor will pay:* A) no tax until she liquidates the shares. B) ordinary income tax rates on the capital gains and dividends. C) capital gains rates on capital gains distributions and ordinary income rates on dividends. D) long-term or short-term capital gains rates, depending on the length of time the customer has held the fund shares.

Your answer, capital gains rates on capital gains distributions and ordinary income rates on dividends., was correct!. Capital gains distributions are taxed as capital gains, with their holding status depending on how long the fund has held the securities, not how long the investor has held the mutual fund shares. Dividend distributions are taxed as ordinary income. Reference: 10.8.1.3 in the License Exam Manual.

*All of the following are characteristics typical of a money market fund EXCEPT:* A) the underlying portfolio consists of short-term debt instruments. B) its net asset value normally remains unchanged. C) it is offered as a no-load investment. D) it has a high beta and is safest in periods of low market volatility.

Your answer, it has a high beta and is safest in periods of low market volatility., was correct!. A money market fund has almost no price volatility, since the underlying portfolio consists of low-beta instruments, and the fund is deliberately managed for low beta. Reference: 10.5.1.6 in the License Exam Manual.

*Capital gains distributed by a mutual fund to shareholders reported and taxable for the year:* A) paid by the fund. B) earned (accrued). C) the shareholder chooses but not later than 2 years after all shares are redeemed. D) the shares are redeemed by the fund.

Your answer, paid by the fund., was incorrect. The correct answer was: earned (accrued). Capital gains can be distributed to shareholders by a mutual fund no more than once per year and are reported and taxable for the year earned (accrued). Reference: 10.8.1.3 in the License Exam Manual.

A customer with no other mutual fund investments wishes to invest $47,000 in the XYZ Technology Fund. If the Class A shares are eligible for a breakpoint sales charge discount at the $50,000 investment level, the action least appropriate for an agent is to: A) inform the customer that he can reduce his sales charge through a letter of intent. B) inform the customer that he can reduce his sales charge by investing an additional $3,000. C) inform the customer that he can reduce his sales charge by combining purchases in other funds offered by XYZ group. D) place the order as instructed.

Your answer, place the order as instructed., was correct!. If a customer intends to invest 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 receive it. Reference: 10.7.5.1.2 in the License Exam Manual.