Unit 3

With regard to taxation of distributions from a REIT, which of these are true? In the majority of cases, dividends are taxed as ordinary income. In the majority of cases, dividends are considered qualified for the lower tax rate. Capital gains distributions are treated as long-term capital gains. Capital gains distributions are taxed as ordinary income. A) I and III B) I and IV C) II and III D) II and IV

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. A I & III

Under the Investment Company Act of 1940, SEC Rule 12b-1 allows a fund to charge distribution and sales expenses to net assets as a percentage of the total assets. Normally, the cost of distribution of the shares is paid by the underwriter out of the sales load paid by the individual purchaser. For a fund to impose 12b-1 charges, which of the following conditions apply (applies)? The board of directors has sole approval authority. The majority of the outstanding shares has sole approval authori

III & IV

A REIT is able to pass-through which of the following? A) Losses from active activity B) Taxable income from operations C) Unrealized capital gains D) Losses from passive activity

REITs are required to distribute a minimum of 90% of their taxable income from operations. Unlike the traditional flow-through vehicle, they do not pass through losses. When a gain is unrealized, there is nothing to distribute. B

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) be listed on an exchange. B) continuously offer additional shares. C) issue more than one class of stock. D) permit reinvestment of dividends.

Unlike open-end companies, which can only issue one 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. C

Under the 1940 Investment Company Act, an investment company may take all of the following forms except A) a limited partnership with partners as passive investors. B) a closed-end investment company. C) an open-end investment company. D) a unit investment trust.

A

If a customer's portfolio is heavily invested in common stock mutual funds, what is the customer's greatest risk? A) Loss of diversification B) Changes in interest rates C) Loss of liquidity D) Loss of principal

A mutual fund with a portfolio of common stock is subject to market risk. If the market falls, the value of the fund's shares also falls, subjecting the owner to loss of principal. D

A hedge fund manager is compensated using the 2 & 20 rate. If the management contract calls for a hurdle rate of 5%, it means that if the fund's return is 20%, A) the manager receives the 2% base rate but no incentive because the return did not exceed the 20% level. B) the manager receives 2% of the 5% hurdle rate and 20% of the 15% in excess of the hurdle. C) the manager's incentive fee applies to the full return because it exceeds the hurdle rate. D) the manager's incentive fee applies to

The hurdle rate in a hedge fund is the minimum performance required before the incentive rate (the 20%) kicks in. That incentive rate applies only to the performance in excess of the hurdle; in this case, 20% exceeds 5% by 15%. D

The Investment Company Act of 1940 allows a majority vote of the outstanding shares of a registered investment company to authorize the fund to do all of the following except A) change from an open-end to a closed-end investment company. B) change the nature of its business and cease to be an investment company. C) invest in securities consistent with the fund's objectives. D) change the objectives of the fund.

Shareholder approval is not necessary to authorize the fund to invest consistent with the fund's objectives; it is required as part of the contract with the fund's investment adviser. Under the Investment Company Act of 1940, a vote of the majority of outstanding shares may approve changing from an open-end to a closed-end company, changing the investment objectives of the fund, and deciding to cease to be an investment company. B

Which of the following statements under the Investment Company Act of 1940 is true? A) Mutual funds furnish financial reports to shareholders at least annually. B) Mutual funds must file semiannual reports with the SEC. C) Investment companies are prohibited from owning more than 5% of another investment company's shares. D) Holding companies are not included in the definition of an investment company.

The act lists three different types of investment companies: face-amount certificate companies, unit investment trusts, and management companies. Holding companies—business entities that 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. D

Which of the following investment vehicles provides for redemption by the issuer? A) Exchange-traded fund (ETF) B) Closed-end fund (CEF) C) Unit investment trust (UIT) D) Face-amount certificate (FAC)

A) UIT*A UIT typically issues redeemable securities (or "units"), like a mutual fund, which means that the UIT will buy back an investor's "units," at the investor's request, at their approximate net asset value. ETFs and CEFs are traded in the secondary markets and investors sell their shares in the marketplace rather than redeeming them through the issuer. Face amount certificates are not redeemable - the investor's funds are returned when the debt is paid off.

A client of yours comes to the office and shows you some sales literature from a mutual fund that has him very excited. According to the material, the fund's average annual return over the past 10 years has been in excess of 15% and it has achieved the highest rating from the major fund rating services. Before recommending this fund to your clients, the first thing you would probably check for in the fund's prospectus is A) the fund's objectives. B) the fund's sales charge. C) the portfolio

Because this client has been "sold" on past performance, you need to verify if the manager achieving those results is still on the job. That is the prime reason why the regulations require disclosure of the fund manager's tenure; it is important for investors to know if the current manager was the one who had the winning streak or if that manager just came on board. The other choices are something to look at, but in this instance, they take a back seat to checking on the manager's tenure. Sure, the expense ratio is important, but the past performance is after expenses, so that has already been taken into consideration. C

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) Purchasing foreign stocks through a mutual fund saves on foreign taxation. B) He would have the benefit of the portfolio managers picking the stocks instead of having to rely on his own efforts. C) The voting rights granted to a mutual fund shareholder are much stronger than those to the holder of an ADR. D) He coul

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. B

When comparing exchange-traded funds (ETFs) to mutual funds, a feature available in ETFs that is not found in the mutual funds would include the ability to A) be bought and sold at a profit the same day. B) correlate to a specific index. C) represent an entire portfolio or basket of securities. D) reinvest dividend distributions.

Unlike mutual fund shares, ETF shares can be traded on an intra-day basis. Mutual funds are priced once per day, after the market closes, but, with an ETF, you can buy and then sell an hour or two later at a profit or a loss. 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. Dividend reinvestment is available on ETFs and mutual funds, although the process tends to be more efficient with the funds. A