Unit 14
Daniel has a number of investment company products within his retirement portfolio. One of these investments trades on an exchange, may trade at a premium or discount to its net asset value, and has a fixed capital structure. These features are most likely found in what type of investment? A) Hedge fund B) Unit investment trust C) Open-end investment company D) Closed-end investment company
D. A closed-end investment company (closed-end fund) is a type of investment company whose shares trade in the secondary market.
Which of the following are characteristics of a money market mutual fund? I. Shares are offered without a sales charge. II. There is a redemption fee. III. All purchasers must receive a copy of the prospectus. IV. The letter of intent must be signed within 16 months.
I and III Money market funds are offered without sales loads or redemption fees. As with all mutual funds, a prospectus is required.
All of the following are characteristics typical of a money market fund EXCEPT A) its net asset value normally remains unchanged B) it has a high beta and is safest in periods of low market volatility C) it is offered as a no-load investment D) the underlying portfolio consists of short-term debt instruments
B. A money market fund has almost no price volatility, because the underlying portfolio consists of low-beta instruments, and the fund is deliberately managed for low beta (see the Glossary of Terms if you are not familiar with beta).
In a mutual fund portfolio, you might find all of the following EXCEPT A) index options B) short stock C) covered calls D) junk bonds
B. 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. Index options 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. Some funds may use covered calls to generate income.
All of the following statements regarding investment companies are correct except A) a unit investment trust is a type of investment company whose units are redeemable at NAV by the trust's sponsor. B) an exchange-traded fund is an investment that can be bought and sold throughout the trading day. C) an open-end investment company is categorized as open end because it is limited in the number of shares that are sold. D) a closed-end investment company is a type of company whose shares trade in the same manner as publicly-traded stocks in the secondary market.
C. An investment company is categorized as open-end because it is not limited in the number of shares sold. ETFs and CEFs (closed-end funds) trade in the secondary markets like any stock. UITs are redeemable at NAV by the trust's sponsor.
Asset-based sales charges will generally be lowest when holding A) Class C shares B) Class R shares C) Class B shares D) Class A shares
D. 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.
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 closed-end investment company B) a blended investment company C) an open-end investment company D) a unit investment trust
A. The only investment company that can legally issue preferred stock is a closed-end investment company. Open-end companies can only issue 1 class of stock (common stock or its equivalent). UITs issue units and term blended investment company makes no sense here.
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) investors would only need to be accredited rather than qualified B) registration would not be required of the investment adviser C) greater liquidity would be assured D) it would be able to have more than 100 investors
B. 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.
Starflier Mutual Fund, regulated under the Investment Company Act of 1940, wishes to change its investment policy. It may do so with approval of A) a majority of the board of directors B) none of these; no need for approval C) a majority of the outstanding shares D) the fund's investment adviser
C. Changes in investment policy require a vote of the majority of outstanding shares for approval.
Daniel has a number of investment company products within his retirement portfolio. One of these investments trades on an exchange, may trade at a premium or discount to its net asset value, and has a fixed capital structure. These features are most likely found in what type of investment? A) Closed-end investment company B) Open-end investment company C) Hedge fund D) Unit investment trust
A. A closed-end investment company (closed-end fund) is a type of investment company whose shares trade in the secondary market.
The tax consequence of transferring proceeds from one fund to another within the same family of funds is: A) on the date of the transaction, any gain or loss is recognized for tax purposes B) gains are taxed and losses are deferred C) no gain or loss is recognized until redemption D) losses are deducted and gains are deferred
A. An exchange is the sale and then a purchase of a new security and is therefore a taxable event.
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) issue more than 1 class of stock B) be listed on an exchange C) permit reinvestment of dividends D) continuously offer additional share
A. Unlike open-end companies, which can only issue 1 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.
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) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee B) decline the transaction because short-term trading of funds is not allowed C) 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 B shares with a declining CDSC and 0.75% 12b-1 fee
C. 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 - 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).
When advising an investor on the purchase of mutual funds, the agent should instruct the client to compare open-end mutual funds with the same objective for all of the following except A) liquidity B) portfolio turnover C) services offered D) costs
A. Shares in an open-end investment company (mutual fund) are liquid. By federal law, all mutual funds are required to redeem shares at their net asset value within 7 days and, therefore, that should not be a consideration in comparing mutual funds with the same objective. Sales loads, management fees, and operating expenses reduce an investor's return. Most of these fees continue throughout the holding period and have a significant impact on performance. Portfolio turnover is significant as gains in the portfolio will likely all be short-term gains, which are usually taxable to the investor at a higher rate than long-term capital gains. Services that mutual funds offer include retirement accounts, investment plans, check-writing privileges, telephone transfers, conversion privileges, withdrawal plans, and others.
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) He would have the benefit of the portfolio managers picking the stocks instead of having to rely on his own efforts. B) The voting rights granted to a mutual fund shareholder are much stronger than those to the holder of an ADR. C) Purchasing foreign stocks through a mutual fund saves on foreign taxation. D) He could select a fund whose portfolio had the proper mix of foreign and domestic stocks to maximize his diversification.
A. 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.
Which of the following statements regarding investment companies is not true? A) The Investment Company Act of 1940 classifies investment companies into 3 types: face-amount certificate companies, unit investment trusts, and management investment companies. B) 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. C) 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. D) 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. 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 3 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.
Although investing in managed investment companies can provide many benefits, investors should be aware that disadvantages could include all of these EXCEPT A) limited liquidity B) high expenses C) unpredictability of tax consequences D) poor management performance
A. Open-end and closed-end are the 2 categories of managed investment companies. Liquidity is never a problem with open-end companies with the federal law requiring redemption at NAV within 7 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
A registered investment company whose portfolio consists of equity securities and the portfolio does not change in response to market conditions is probably A) an ETN. B) a unit investment trust. C) a closed-end investment company. D) a passively-managed mutual fund.
B. Unit investment trusts are registered investment companies with a fixed portfolio. That is, at the time of organization, the portfolio is purchased and, because there is no ongoing management company, there are basically no changes made.
A client investing $50,000 into the KAPCO Growth Fund would most likely be eligible for a breakpoint if purchasing A) the Class C shares B) the Class B shares C) the closed-end shares D) the Class A shares
D. Breakpoints for quantity purchases are available on shares that carry a front-end load. Those are Class A shares. Class B shares have a back-end load, Class C shares are considered level load, and when one purchases shares of a closed-end company, commissions are charged, as would be on any stock purchase.
