chapter 19

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Compare and contrast an open-end (mutual fund) investment fund with a closed-end investment company.

Closed-end investment companies start with a set number of shares of various companies and are usually listed on an exchange. The number of shares in a mutual fund is open-ended, and is dependent upon new shares issued (at NAV) and redeemed. Closed-end funds often trade at a discount or a premium to their net asset value, the estimated market value of the fund securities.

Class A mutual fund shares are always a poorer choice than Class B shares for a long term investor. (T/F)

F

Closed end funds that trade at a value different than their NAV provide clear evidence of inefficient market pricing. (T/F)

F

Closed-end investment companies stand ready to redeem their shares at their NAV less a management fee. (T/F)

F

Due to the ability to hedge, the investors of hedge funds experienced very minor losses in subprime mortgage crisis from 2007 to 2009. (T/F)

F

Hedge funds have been popular diversification investments for small investors. (T/F)

F

Income funds are made up of portfolios of mortgage-backed securities only. (T/F)

F

No-load mutual funds are commonly sold by security brokers and dealers. (T/F)

F

REIT activities are governed by the Investment Company Act of 1940. (T/F)

F

REITs are open-end investment companies that invest in real estate. (T/F)

F

Unit investment trusts have a high security turnover rate, increasing their costs over equivalent mutual funds. (T/F)

F

When purchasing a load mutual fund, the NAV includes the load charge for purchasing the mutual funds. (T/F)

F

While closed end funds may trade at a discount, they never trade at a premium due to arbitrage. (T/F)

F

Why have exchange-traded funds become popular in the last few years? Name one and specify what it tracks.

First introduced in 1989 at the Toronto Stock Exchange, exchange-traded funds are investment companies whose shares are traded on organized exchanges, similar to closed-end funds. Buyers deposit a specific portfolio of stocks, usually a stock index portfolio, and redeem their ETF shares for stock as well. Arbitrage keeps the NAV of the underlying and the ETF shares very close to each other. American Stock Exchange's Standard & Poor's Depository Receipts (SPDRS) is one of the more popular ETF's. They are popular because the allow intra-day trading, unlike mutual funds, have low expense ratios, and allow investors to track broad market indices or specific market segments at a low transaction cost.

Why are there so many different mutual funds offered for sale? Why have index funds become more popular?

First, a tremendous flow of money into mutual funds has occurred over the last thirty years with each investor having a different risk profile and expectations. This presented opportunities for many fund managers and fund families. Stock index funds have also grown in popularity as more evidence has indicated that actively managed funds have difficulty outperforming the market over time after accounting for expenses. The lower expense ratios of index funds have been popular with investors in recent years.

How do hedge funds take advantage of capital market inefficiencies and end up making the markets more efficient?

Hedge funds often find price discrepancies in derivative securities and their underlying assets, such as stock index funds and the associated portfolios of stocks. They exploit these discrepancies by taking long positions in relatively underpriced instrument and short positions in relatively overpriced ones. This trading activity reduces or eliminates price discrepancies among different but related assets or markets, thereby increasing market efficiency.

How is the marketing channel of distribution different for load mutual funds vs. no-load funds?

Load funds, paying an up-front sales commission, are more likely to be offered by commission security representatives (brokers), whereas no-load funds are likely to be sold via a 1-800 number or via the Internet rather than by brokers.

Arbitrage activities of hedge funds tend to increase capital market efficiency. (T/F)

T

Arbitrage by hedge funds is the simultaneous buying and selling of a security or derivative of the security to exploit market pricing differentials. (T/F)

T

Balanced funds generate higher proportion of income than growth and income funds and are less volatile. (T/F)

T

Closed-end investment companies' securities often sell at a discount to their NAV. (T/F)

T

Commodity ETFs are not investment companies. (T/F)

T

Hedge funds are typically organized as limited partnerships with the fund manager as the general partner. (T/F)

T

Load mutual fund shares may be sold back to the fund. (T/F)

T

Money market mutual funds are not subject to reserve requirements. (T/F)

T

Money market mutual funds invest in commercial paper, large bank CDs, and short-term government securities. (T/F)

T

Most hedge funds are not investment companies. (T/F)

T

Mutual funds offer diversification and professional investment management for the fees charged. (T/F)

T

One of the benefits of investing in hedge funds is that some hedge funds are not subject to taxation on fund distributions nor to U.S. estate taxes. (T/F)

T

Open end mutual funds have largest share of investment company assets. (T/F)

T

REITs are exempt from federal income tax provided that they derive at least three-fourths of their income from operations related to real estate and pass through more than 90 percent of their net income to shareholders. (T/F)

T

The National Securities Markets Improvement Act of 1996 assigned federal regulators sole jurisdiction over the structure and operations of mutual funds and mutual fund prospectuses. (T/F)

T

The major investment of mutual funds is common stock. (T/F)

T

There is more money invested in hedge funds than in exchange‐traded funds, closed‐end funds, and unit investment trusts combined (T/F)

T

Unlike mutual funds where their leverage is limited by regulation, hedge funds and REITs often have high leverage. (T/F)

T

You invest $1,000,000 in Formosa Growth Fund. The Fund charges a front end load of 5.75% and an annual expense fee of 1.25% of the average asset value over the year. You believe the fund's gross rate of return will be 11% per year. What will your investment portfolio be worth in one year?

The beginning Investment amount = $1,000,000 (1-0.0575) = $942,500. After one year, the future value = $942,500(1+0.11) = $1,046,175. Therefore, the average asset's value = ($1,046,175+$942,500)/2 = 994,337.5. We then obtain the annual expense fee = $994,337.50.0125= $12,429. The ending value of the portfolio = $1,046,175 - $12,429 = $1,033,746

12b-1 fees help mutual funds pay for a. marketing expenses b. costs of trading securities c. management salaries d. account maintenance costs

a

An in an unmanaged pool of assets is an investment in a a. mutual fund b. closed-end fund c. MMMF d. UIT

a

Between 1995 and 2015 investment company assets had annual compound growth of about ___ percent in an already large market. a. 9 b. 10 c. 11 d. 12

a

Equity funds usually charge ______ fees than bond funds and fees for both types of funds have been ______. a. higher; falling b. higher; increasing c. lower; falling d. lower; increasing

a

The law that preempted most state oversight of investment company activity and entrenched federal oversight of mutual fund structure, operations and prospectuses was the a. National Securities Markets Improvement Act. b. Investment Company Act. c. SEC Act. d. Mutual Fund Investment Transparency Act.

a

The major regulatory body representing mutual fund investors' interest is the a. Securities and Exchange Commission b. Security Investors Protection Commission c. Federal Reserve System d. Federal Trade Commission

a

Which of the following mutual fund types is likely to have the lowest expense ratios? a. index funds b. aggressive growth funds c. growth and income funds d. international and global equity funds

a

Which one of the following is not true about balanced funds? a. Such funds are typically comprised of portfolios of mortgage securities and preferred stock. b. The proportions of stocks and bonds determine the level of return for each fund. c. They typically generate a higher proportion of income than growth and income funds and are less volatile. d. Investors who have a few more years to retirement and are typically in their early 50s are attracted to such funds.

a

You have $200,000 to invest in a mutual fund with a NAV equal to $70. This fund has a 4% front load, a 1% of management fee and a 0.25% 12b-1 fee. Assume that the management and 12b-1 fees are charged based on year-end asset value. The gross annual return on the fund's shares was 9%. What was your net annual rate of return to the nearest basis point? a. 3.33% b. 7.64% c. 6.25% d. 4.52% e. 4.64%

a

What are the benefits that investment companies and mutual funds provide to the public?

a. Provide risk diversification by investing in a portfolio of assets. b. Denomination intermediation by allowing small minimum investments. c. Enhance liquidity of long-term investments. d. Increase economies of scale in investment management and reduce average transaction costs. e. Provide record keeping for tax purposes.

52. Rank the following in the proportion of stock likely to be held in the fund from highest to lowest: I. growth fund II. balanced fund III. income fund IV. aggressive growth fund a. IV, I, III, II b. IV, I, II, III c. III, II, I, IV d. I, II, III, IV

b

A mutual fund "load" refers to a. the operating expenses charged against the assets. b. the sales commissions paid to brokers. c. the sum of the commissions paid for buying and selling the assets of the fund. d. the fees paid to the investment manager.

b

A mutual fund is allowed to advertise as 'No Load' if its combined 12b-1 and shareholder service fee is no more than ______ of NAV. a. 0.10% b. 0.25% c. 0.50% d. 1.00%

b

An authorized participant in an ETF fund exchanges fund shares for shares of the underlying portfolio or exchanges the securities that make up the underlying portfolio for fund shares in order to a. protect investors' rates of return in illiquid periods. b. minimize the fund premium or discount from NAV. c. provide liquidity to investors. d. meet investment company act transparency requirements.

b

Investment funds provide investors all of the following except: a. diversification. b. contractual rate of return. c. professional advice. d. small minimum investment.

b

Money market funds include various types. Which type is called a prime fund? a. taxable government money market funds. b. taxable nongovernmental money market funds c. tax-exempt money market funds d. tax-exempt municipal market funds

b

Money market mutual funds (MMMFs) became popular in the 1970s because a. MMMF balances were insured by FDIC, unlike bank deposits b. MMMF were allowed to pay market rates on their balances, while commercial banks faced interest rate ceilings. c. MMMF balances were more liquid than any bank deposits. d. MMMF activities are not regulated at the federal level.

b

Mutual fund management companies offering families of funds are attractive to investors focused on funding their retirement because they a. provide high return, low risk funds. b. provide an opportunity to easily alter the investment portfolio as the investor ages. c. they provide significant "load" fees for customers. d. they are not regulated like most mutual funds.

b

Target date funds are designed to a. time the market via changing the fund's asset allocation according to market conditions. b. reduce risk as investors' retirement date approaches. c. actively seek undervalued growth opportunities in stocks. d. mimic the performance of broad market indices.

b

The largest investments of mutual funds are in _______, followed by_______. a. bonds; common stocks b. common stocks; bonds c. common stocks; preferred stocks d. money market securities; common stocks

b

Which of the following is not an advantage of exchange-traded funds compared to a mutual fund investment? a. better tax timing options on ETFs than on mutual funds b. stock selection to find undervalue stocks c. low expense ratio d. ease of buying and selling

b

Which of the following is not associated with the growth of mutual funds in recent years? a. an increasing number of retiring baby boomers b. a widespread shift from defined contribution to defined benefit retirement plans c. the increased variety of mutual funds offered d. the attractive rates of return on common stock

b

Which of the following mutual fund types is likely to have the highest risk exposure? a. growth and income funds b. aggressive growth funds c. balanced funds d. income-equity funds e. money market funds

b

Which type of investment company allows shareholders to cash in their shares at their present net asset value? a. unit investment trusts b. open-end investment companies c. closed-end investment companies d. real estate investment trusts

b

You consider investing $10,000 in a stock mutual fund and you are choosing between Fund A, which has a front-end load of 3%, and Fund B, which has a back-end load of 3%. Expected returns and fees of the two funds are identical. Which fund would you choose? a. Fund A b. Fund B c. You are indifferent (total expected returns are the same after accounting for the loads) d. More information is needed to make the choice.

b

An investment in a 3% front-end load mutual fund with a $20 NAV would cost the investor per share: a. $20.00 b. $19.40 c. $20.60 d. $23.00 e. $17.00

c

An open end mutual fund owns 1500 share of Crispy Creme priced at $12. The fund also owns 1000 shares of Bem & Jarry's priced at $43, and 2000 shares of Pepsi priced at $50. The fund itself has 3500 of its own shares outstanding. If the fund has no liabilities, what is the NAV of a fund's share? a. $66 b. $56 c. $46 d. $36 e. $26

c

At the end of 2015, the top ______ fund families controlled ______ percent of total mutual fund assets a. 10; 80 b. 15; 70 c. 25; 75 d. 30; 90

c

Investors may choose to hold a corporate bond fund rather than an equity fund because they a. want more capital appreciation. b. want to minimize their tax liability. c. prefer less return variability. d. do not want to chance a loss in their principal invested. e. don't mind paying higher fees to gain the extra liquidity.

c

Money market funds are included in the definition of the money supply because a. they are invested in high quality assets. b. they are invested in short-term assets. c. they are liquid. d. they are insured by the government.

c

Money market mutual funds compete mostly with banks' a. demand deposits. b. time deposits. c. MMDAs. d. regular savings accounts.

c

Most ______ investments are not available to the general public. a. money market mutual fund b. closed end fund c. unit investment trust d. hedge fund

c

Mutual funds that do not charge a front-end load can still impose a _______ that must be paid by investors who redeem their shares. I. back-end loadII. redemption feeIII. 12b-1 feeIV. up front commission a. I only b. I and II only c. I, II and III only, d. II, III and IV only e. I, II, III and IV

c

No-load mutual funds compensate investment managers and salespeople by a. charging a fee to the buyer of new shares. b. charging a fee based on the performance of the fund. c. charging a fee to all fund investors based on the value of the fund's assets. d. charging brokers a fee to sell the shares.

c

Real estate investment trusts are ________ investment companies that tend to prosper when a. open-end; interest rates are low. b. open-end; interest rates are high. c. closed-end; interest rates are low. d. closed-end; interest rates are high

c

The capital gains and earnings of mutual funds a. are taxed at a lower rate than individuals', a major aspect of their popularity. b. are taxed only on the interest income, not the capital gains, a major aspect of their popularity. c. are not taxed at the fund level as long as they distribute a very high proportion of earnings to shareholders. d. are not taxable for either the fund or the fund investor.

c

The key advantage of a family of mutual funds is a. the ability to diversify an investment portfolio. b. the ability to add funds on a regular basis such as with a 401K retirement plan. c. the ability to shift quickly from one type of mutual funds to another with little or no cost and without rolling over 401K monies. d. the ability to shift from one mutual fund management company to another.

c

The majority of securities owned by open-end mutual funds are: a. real, physical assets. b. money market securities. c. capital market securities. d. safe, low-risk government securities.

c

The price of a mutual fund share is a. the total value of mutual fund shares divided by the number of corporate shares held. b. the number of shares issued divided by the number of corporate shares owned. c. the value of assets minus expenses all divided by shares issued. d. the number of shares of corporate stock held divided into the total value of the stock portfolio.

c

Which of the following is best associated with hedge fund investors? a. employees in a 401k pension plan b. commercial banks c. high net worth individuals and institutions d. investors seeking to hedge their business risk

c

Which one of the following services is not provided by closed-end investment companies? a. transaction cost economies b. risk diversification c. redemption of shares on demand d. shared costs of investment management

c

You have $15,000 to invest in a mutual fund. You choose a fund with a 3.5% front load, a 1.75% management fee and a 0.5% 12b-1 fee. Assume that the management and 12b-1 fees are charged on year end assets for simplicity. The gross annual return on the fund's shares was 12.50%. What was your net annual rate of return to the nearest basis point? a. 9.97% b. 8.25% c. 6.12% d. 5.42% e. 4.56%

c

A fund with only a back-end load will likely have an initial cost of the a. NAV less the load. b. NAV plus the 12b-1 fees. c. NAV plus the back-end load d. NAV.

d

As the economy does better assets invested in ______ tend to decline and assets invested in ______ tend to increase. a. equity funds; MMMFs b. equity funds: bond funds c. bond funds; MMMFs d. MMMFs; equity funds

d

Closed-end funds can sell at a discount to their NAV for which of the following reasons? I. poor management II. illiquidity III. built in tax liabilities a. I only b. I and II only c. II and III only d. I, II and III

d

FINRA has set the maximum front-end load on a mutual fund to be ______. a. 5.5% b. 6.5% c. 7.5% d. 8.5%

d

If a hedge fund manager focused on short-selling of stocks, he/she would a. invest in company stock for short-term profits. b. invest in companies with high future growth prospects. c. borrow money to invest in stocks. d. select companies where the future supply of securities for sale is expected to exceed demand.

d

Load mutual funds are sold at a. the best price an underwriter can get. b. their present net asset value. c. their present net asset value less a discount. d. their present net asset value plus a commission charge,

d

MMMFs compete primarily with a. growth and income funds b. T-bills c. short term derivatives d. bank deposits

d

Most hedge funds are typically organized as ______. a. investment banks b. hedge funds c. REITs d. limited partnerships

d

Mutual fund companies provide all but one of the following to their customers: a. diversification b. payment services c. discount brokerage d. insurance against losses

d

One may find the shares of which of the following traded on an exchange? I. money market mutual fundII. open-end investment company.III. closed-end investment company.IV. ETF a. I and II only b. I and III only c. III only d. III and IV only e. II, III and IV only

d

Open-end investment companies are also called ________ and are called "open-end" because a. high risk funds; they are able to assume high levels of risk. b. venture capitalists; they invest in the stock of firms. c. mutual funds; they can buy an unlimited number of corporate shares. d. mutual funds; they can issue an unlimited number of shares to investors.

d

Rank the following from high risk to low risk: I. growth fund II. balanced fund III. growth and income fund IV. MMMF a. I, II, III, IV b. III, I, IV, II c. IV, II, III, I d. I, III, II, IV

d

Unit investment trusts are associated with a. actively managed, short lived assets. b. passively managed, short lived assets. c. actively managed, long lived assets. d. passively managed, long lived assets.

d

Which of the following can trade on national exchanges? a. MMMF b. open-end investment company c. no-load mutual fund d. Exchange-Traded Funds(ETF)

d

Which of the following is not a correctly stated concerning hedge funds and mutual funds? a. Mutual funds are registered with the SEC, while hedge funds are not. b. Unlike mutual funds, hedge funds borrow significant amounts of their capital. c. Unlike mutual funds, hedge funds concentrate their investment in very few areas. d. Both hedge funds and mutual funds are open to all investors.

d

Money market mutual funds do NOT invest in a. commercial paper and banker's acceptances. b. bank CDs. c. U.S. Treasury bills. d. repurchase agreements. e. U.S. Treasury notes and bonds.

e


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