Unit 14: Types of Pooled Investments
When an open-end management investment company computes its net asset value per share, each of the following occurrences would have an impact EXCEPT: A. a capital gains distribution B. a greater value of shares being redeemed than purchased C. interest payments made on debt securities held in the fund's portfolio D. a drop in the value of equity securities held in the fund's portfolio
Answer: B.
Who safeguards the securities held in a mutual fund's portfolio? A. trustee B. custodian C. the corporation D. the manager
Answer: B. The Investment Company Act of 1940 requires that investment companies employ the services of a commercial bank as custodian to hold and safeguard the physical assets (cash and investment portfolio) of the fund.
When investing in mutual funds, each of the following is a sales charge EXCEPT: A. back-end load B. CDSC C. 12b-1 fees D. front-end load
Answer: C. 12b-1 fees are not defined as sales charges because they are not a function of buying or selling your shares. These fees are asset-based, generally charged quarterly, and come out of the NAV. Front-end loads and back-end loads (CDSCs) are charged either when you buy the fund (front end) or sell your shares (back-end).
To be in compliance with the Securities Act of 1933, the sale of which of the following securities would require delivery of a prospectus? I. Primary offering of a closed-end investment company registered under the Investment Company Act of 1940 II. Primary offering of 5-year U.S. Treasury notes sold to an individual investor III. Private placement sold under the provisions of Regulation D IV. Sale of shares of an open-end investment company whose first public offering was 23 years ago A. II and III B. I and II C. I and IV D. III and IV
Answer: C. Any primary offering, unless the security is exempt, requires timely delivery of a prospectus. Treasury notes and private placements are exempt.
Which of the following is NOT a characteristic of hedge funds? Hedge funds: A. are privately organized and generally unlisted. B. invest in private securities, real assets, derivatives, and structured products. C. offer managers high fixed fees D. use leverage, short positions, and concentrated positions.
Answer: C. Hedge funds tend to attract the top managers because they offer performance-based fees, which vary based on fund performance.
The Investment Company Act of 1940 states that: A. an investment company must have $5 million capital before its securities can be offered to the public B. no more than 50% of the board of directors of an investment company may be officers or employees of the company or investment advisers to the company C. open-end companies may issue common stock only D. it is unnecessary for the prospectus to disclose the management fee
Answer: C. Open-end companies may issue only common stock. The prospectus must state the management fee, and an investment company needs only $100,000 to offer itself to the public. In addition, no more than 60% of the board of directors can be made up of officers or employees of the company.
A customer invests $18,000 in a mutual fund and signs a letter of intent for $25,000 to qualify for a breakpoint. One year later, the shares are valued at $25,100, even though the customer has made no new investments. Which of the following statements is TRUE? A. Shares held in escrow will be liquidated at the appreciated value. B. The investment no longer qualifies for a breakpoint. C. The letter of intent is considered fulfilled. D. The agent should remind the customer of the letter of intent that was signed 12 months ago.
Answer: D. The letter of intent is not satisfied by the price appreciation of the shares. A letter of intent must be met with dollars invested within 13 months, so the customer needs to invest an additional $7,000 to fulfill the letter of intent. The agent should remind the customer of the intention to qualify for the reduced sales charge. The provisions of the LOI hold regardless of the price appreciation. Shares will not be liquidated until 13 months have lapsed.
Which of the following investments is the most liquid? A. Variable annuities B. Money market funds C. Common stock D. Foreign stock funds
Answer: B. Money market funds are the most liquid investment. In virtually all cases, they come with check-writing privileges.
One of your clients wishes to invest in a fund of hedge funds. You could tell him which of the following? A. Shares of these funds are easy to redeem. B. He can expect to make a profit whether the markets trend up or trend down. C. Expenses for these funds tend to be higher than those for other funds. D. These funds purchase a large amount of preferred stock.
Answer: C. Funds of hedge funds purchase interests in a variety of hedge funds, which typically use risky strategies to generate profit regardless of market direction. Redemption may be difficult with these funds, and the steps management must take to try to generate profits incur higher expenses than traditional mutual funds.
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. costs B. portfolio turnover C. services offered D. liquidity
Answer: D. 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.
Your married customers, ages 48 and 50, have a combined annual income of more than $200,000. They are concerned about the effects of rising inflation, and because they are heavily invested in bonds, they seek to invest a portion of their portfolio in a fund that will provide additional diversification. Which of the following mutual funds is the most suitable for these customers? A. ATF Overseas Opportunities Fund B. ABC Investment-Grade Bond Fund C. NavCo Tax-Free Municipal Bond Fund D. XYZ Government Income Fund
Answer: A. Investment in an overseas equity fund will provide diversification not necessarily subject to U.S. inflation. The tax-free fund will not provide additional diversification nor the best hedge against inflation. A high-grade bond fund will not add diversification.
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. closed-end investment company C. Unit investment trust D. open-end investment company
Answer: B. A closed-end investment company (closed-end fund) is a type of investment company whose shares trade in the secondary market.
A registered investment company whose capitalization may include preferred stock and/or bonds is: A. the face-amount certificate company. B. the unit investment trust. C. the closed-end management investment company. D. the open-end management investment company.
Answer: C. Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds).
Under the Investment Company Act of 1940, which of the following would be considered an affiliated person? I. Persons who control, are controlled by, or share common control with the company II. Any officer, director, or employee of the company III. Persons who own or control 5% or more of the voting shares of the company A. I, II, and III B. I and III C. III only D. II and III
Answer: A. Affiliated persons are any investment company directors, officers, employees, or owners of 5% or more of the voting shares of stock, and/or any persons controlling or controlled by such persons.
With regard to taxation of distributions from a REIT, I. in the majority of cases, dividends are taxed as ordinary income II. in the majority of cases, dividends are considered qualified for the lower tax rate III. capital gains distributions are treated as long-term capital gains IV. capital gains distributions are taxed as ordinary income A. I and III B. II and III C. I and IV D. II and IV
Answer: A. Although there are some rare exceptions, you should consider any dividend paid to an investor in a REIT subject to taxation at ordinary income rates. Just as with mutual funds, capital gains distributions are treated as long-term capital gain.
Which of the following statements regarding a mutual fund that offers class A, B, and C shares are TRUE? I. Class A shares have a front-end sales charge and a low 12b-1 fee. II. Class B shares have a declining contingent-deferred sales charge and a high 12b-1 fee. III. Class C shares have a high 12b-1 fee and a level contingent-deferred sales charge. IV. Class B and C shares allow investors to put the shares back to the fund for their original purchase price for up to 1 year after purchase. A. I, II, and III B. I only C. I and II D. I, II, III, and IV
Answer: A. There is no put provision that guarantees the return of an investor's purchase price associated with mutual fund shares.
A mutual fund's computed NAV on April 24 is $100 per share. On April 25, the portfolio realized gains of $2 per share, and enjoyed $1 per share in unrealized appreciation. What would the NAV be on April 26 assuming an unchanged market? A. $100 per share B. $101 per share C. $103 per share D. $102 per share
Answer: B. A mutual fund's net asset value per share (NAV) is the fund's total assets minus total liabilities (net asset) divided by the number of shares outstanding. The major asset is the fund's portfolio. Portfolio securities are carried at their value as of the close of the markets (4PM ET). As a result, unrealized appreciation (and depreciation) are part of the NAV. Therefore, when that gain (or loss) is realized, paper profit (or loss) is now real and there is no change to total assets. In the subject question, the realization of the $2 per share gain has no effect, but, the new $1 in unrealized appreciation increases the NAV by that amount.
A pooled investment fund buys all the shares of a publicly-traded company. The fund takes the company private, reorganizes the company, and replaces its management team. Three years later, the fund exits the investment through an initial public offering of the company's shares. This pooled investment fund is best described as: A. a leveraged ETF B. Private equity fund C. Hedge fund D. Venture capital fund
Answer: B. A private equity fund or buyout fund is one that acquires entire public companies, takes them private, and reorganizes the companies to increase their value. A hedge fund will rarely get involved with reorganizing an existing company. Venture capital funds invest in start-up companies. Leveraged ETFs do not take part in the management of their investments.
A management investment company owns portfolio securities with a current market value of $100 million. The company owes $10 million for securities purchased but not yet paid for and accrued management fees of $5 million. If there are 2,611,437 shares outstanding and the current asking price of the shares is $36.38 per share, it would be correct to state that this investment company is: A. selling at NAV B. selling at a premium C. selling at a discount D. an open-end investment company
Answer: B. When a closed-end investment company is selling at a price in excess of its net asset value, it is said to be selling at a premium. The net asset value per share of a management investment company (either open-end or closed-end) is computed by dividing the net assets (assets minus liabilities) by the number of outstanding shares. In this example, the net assets are the $100 million portfolio value minus the liabilities of $10 million for the unpaid securities plus the $5 million in accrued management fees. That leaves $85 million divided by the 2,611,437 shares outstanding, which is approximately $32.55. Once we know the NAV, it is clear that the price of $36.38 is a premium over the NAV. And, we know that this can't be an open-end investment company because if it was, the $3.83 sales charge represents 10.5% of the asking price, well in excess of the maximum 8.5% permitted.
Which of the following statements regarding REITs are NOT true? Investors receive flow-through benefits of income as well as loss. I. Hybrid REITs own properties, as well as make loans on others. II. Equity REITs are prohibited from using leverage to acquire properties. III. REITs are easily traded in the secondary market. IV. REITs are easily traded in the secondary market. A. I and IV B. II and IV C. II and III D. I and III
Answer: C. It is not true that REITs offer flow-through of losses; they are not DPPs. As with most real estate purchasers, leverage, usually in the form of a mortgage, is used to acquire property. A hybrid REIT contains the features of both an equity REIT and a mortgage (debt) REIT, and most REITs trade on the exchanges or Nasdaq. Note: Even though there has been an increase in the number of non-traded REITS, unless something in the question indicates that, the question will be dealing with publicly traded REITS.
A mutual fund would have net redemptions when: A. the fund is performing below the average of other funds with the same objectives B. the fund manager is selling more securities in the portfolio than are being purchased C. the number of shares being liquidated by investors exceeds those being purchased D. the fund increases its sales charge
Answer: C. One of the characteristics of an open-end investment company (mutual fund) is the ease of redeeming holdings. When the dollar amount of shares being redeemed exceeds that of those being purchased, the result is net redemptions. Although poor performance could lead to net redemptions, that is not always the case, so it is not always a true statement.
When comparing the pricing of open-end investment companies with that of closed-end investment companies, it is correct to state that: A. both must compute their NAV at least once every day as of the close of trading. B. shares of closed-end funds are generally priced higher than open-end shares. C. only the open-end bases its price on the next computed net asset value per share. D. the closed-end can issue common and preferred shares; the open-end can only issue one class of stock.
Answer: C. The pricing of open-end shares (mutual funds) is based on the next computed NAV per share (forwards pricing), while closed-end shares (CESs) trade based on supply and demand. There is no correlation between share prices and fund structure. Only the open-end must perform a daily NAV computation; closed-end funds may compute daily, but many do it only weekly. It is correct to state that closed-end funds can issue preferred stock in addition to common stock and open-end funds can only issue one class of stock, but that has nothing to do with comparing the pricing of the two.
Which of the following statements under the Investment Company Act of 1940 is TRUE? A. Investment companies are prohibited from owning more than 5% of another investment company's shares. B. Mutual funds must file semiannual reports with the SEC. C. Mutual funds furnish financial reports to shareholders at least annually. D. Holding companies are not included in the definition of an investment company.
Answer: D. The Act lists three different types of investment companies: face amount certificate companies, unit investment trusts and management companies. Holding companies, business entities which invest in other companies for the purpose of management control, are not included in the definition. The limit on investment in another investment company's shares is 3%, not 5%. Section 30(d) of the act requires semiannual reports from the fund to its shareholders and an annual filing with the SEC.
An agent has recommended investments in the XYZ fund family to his customers for 10 years. He is referred by one of his customers to a prospect who has inherited $500,000 as beneficiary of a life insurance policy. The prospect tells the agent she has never invested in the market before, is risk averse, and wants safety of principal to be the first priority with liquidity second. The agent recommends the following investments: - XYZ government bond fund, B shares $200,000 - XYZ large-cap growth and Income B shares $150,000 - liquid reserve money market $150,000 The recommendation is: A. suitable because he recommended conservative investments B. suitable because it addresses the customer's liquidity objective C. suitable because it addresses the customer's safety objective D. unsuitable because it does not address the customer's two primary objectives
Answer: D. The customer's objectives of safety and liquidity are not satisfied by these recommendations. The government bond fund and large-cap growth and income fund are both subject to market risk and, as Class B shares, are subject to a contingent-deferred sales charge in the event the customer wishes to access the funds before the back-end load expires. The back-end load is not consistent with the customer's liquidity objective.
You have a client who originally invested $25,000 into the ABC Growth Fund. Over the past 5 years, there have been no distributions and the value of the shares is now $35,000. If the client should ask about exchanging the entire holding for shares of the ABC Income Fund, you would explain: A. the new shares will have the same cost basis as the old ones B. that taking advantage of the exchange privilege results in taxes being deferred until the liquidation of the account C. the new shares would be acquired at the public offering price D. there is a long-term capital gain of $10,000
Answer: D. The exchange privilege permits shares of one fund in the family (The ABC Fund Group) to be exchanged for shares of another at net asset value, not public offering price. However, for tax purposes, it is considered a sale and a purchase so there would be a capital gain realized on any difference between the cost basis and the proceeds. In this case, the new shares would have a new cost basis of $35,000.
