series 7TO- unit 8 investment companies
Investment clubs 1. can take advantage of breakpoints on mutual fund purchases. 2. cannot take advantage of breakpoints on mutual fund purchases. 3. are permitted to purchase new equity issues at the public offering price (POP). 4. are not permitted to purchase new equity issues at the POP.
2. cannot take advantage of breakpoints on mutual fund purchases. 3. are permitted to purchase new equity issues at the public offering price (POP).
An investor wants to invest $200,000 in the banking industry sector. The investor would like to use leverage and make this purchase in a margin account. Additionally, she stresses wanting to avoid year-end tax statements showing capital gains liabilities. You would suggest which of the following as suitable, given the investor's criteria? A) A bank sector exchange-traded fund (ETF) B) A money market fund holding short-term bank notes C) Stocks in the three largest U.S. banks D) A bank sector mutual fund
A) A bank sector exchange-traded fund (ETF) The investor's criteria eliminates mutual funds as suitable. Mutual funds make annual capital gains distributions for which the owner incurs a tax liability, and mutual funds cannot be purchased on margin. Conversely, an ETF will rarely make a capital gains distribution, and because they trade like all exchange-traded products, they can be purchased on margin, making them more suitable for this investor. Buying only a few select bank stocks is not a good representation of the entire sector. LO 8.h
Securities transactions take place in the primary and secondary markets. Which of the following investment companies can trade in both? A) A closed-end fund B) A face amount certificate company C) An open-end fund D) A unit investment trust
A) A closed-end fund All of these can have primary market transactions. In the case of the closed-end investment company (CEF), it is the initial public offering and, if desired, an additional public offering. The CEF is the only one of these choices where shares trade in the secondary markets. Investors holding shares of a CEF can trade the shares freely, just like any other stock. However, owners of the other types of investment companies will find there is no market for their shares if they wish to sell. That is not a problem, though, because these investment companies stand ready to redeem shares continuously. Technically, when the UIT buys back its shares, it is considered a secondary market transaction. However, for exam purposes, because the trust is the only buyer in the marketplace and the price is not subject to negotiation, it is not a true secondary market transaction. LO 8.c
If a client prefers mutual fund investments in companies that primarily generate capital appreciation to companies that pay a steady dividend, what type of mutual fund and associated investment objective would you recommend? A) A growth fund B) An index fund C) A growth and income fund D) An income fund
A) A growth fund A growth mutual fund invests in stocks that are growing rapidly and stresses capital appreciation rather than income. The key is that the growth and appreciation are synonymous. LO 8.g
One of your customers is in the highest income tax bracket. The customer is looking to invest $250,000 into mutual funds with an objective of receiving income with relative safety. Which of the following funds should you recommend to meet that objective? A) A municipal bond fund B) A money market fund C) A corporate bond fund D) A U.S. Treasury bond fund
A) A municipal bond fund At least for purposes of selecting the correct answer on the exam, whenever you see high tax bracket, the choice is going to be municipal bonds. Because those bonds pay tax-free interest, they are highly attractive to those in high tax brackets. Even though the mutual fund is paying a dividend, the IRS treats the dividends from a bond fund the same as the interest paid by the individual bonds in the portfolio. Therefore, the dividends paid by a municipal bond fund carry tax-free treatment. Dividends paid by all the others are taxable. If the question had said the highest safety, then it would have been the U.S. Treasury bonds, but that would never be the question when a high tax bracket is in the question. LO 8.g
A young first-time investor wants to put $10,000 of savings in an investment that she wants to see grow over many years. She intends to add to it in small amounts whenever able. A balanced mutual fund and an equity growth fund are chosen. What would be the most suitable share class for this initial investment? A) B shares B) D shares C) C shares D) A shares
A) B shares B class shares have a back-end load (sales charge) only payable when the shares are redeemed, and those sales charges dissipate typically over the first five to seven years. Until they disappear completely, the investment is help beyond that time. This is why B shares are generally most suitable for smaller investments (where taking advantage of breakpoints would not be a factor) made with a longer investment time horizon such as this one. LO 8.d
According to investment company rules, open-end investment companies may not distribute long-term capital gains to their shareholders more frequently than A) annually. B) quarterly. C) semiannually. D) monthly.
A) annually. Under the Investment Company Act of 1940, investment companies may not distribute long-term capital gains more frequently than once per year. LO 8.f
All of the following must be sold with a prospectus except A) closed-end funds in the secondary market. B) an IPO of common stock. C) open-end funds in the primary market. D) closed-end funds in the primary market.
A) closed-end funds in the secondary market. Securities sold in the secondary market do not have a prospectus delivery requirement. LO 8.c
Net asset value (NAV) per share for a mutual fund can be expected to decrease if A) the fund has made dividend distributions to shareholders. B) the fund has experienced a net redemption of shares. C) the securities in the portfolio have appreciated in value. D) the issuers of securities in the portfolio have made dividend distributions.
A) the fund has made dividend distributions to shareholders. The NAV per share will rise or fall relative to the value of the underlying portfolio. If dividends are distributed to shareholders, the fund's assets decrease, and their per-share value will decline accordingly. Appreciation of the portfolio and dividends received will increase the value. Redemption of shares will have no impact on the NAV per share, as the money paid out is offset by a reduced number of shares outstanding. LO 8.c
If a registered representative is seeking to sell shares of an investment company to a client, which of the following statements would be accurate and permissible regarding her recommendation? 1. When the client redeems his shares, he will not immediately know their dollar value. 2. If the client invests just before the dividend distribution, he can benefit by receiving the added value of that dividend. 3. If the client purchases the shares of two or more funds in the same family of funds, he may be entitled to a reduced sales charge. 4. The purchase of Class B shares always provides the greatest return on investment. A) II and III B) I and III C) I and IV D) II and IV
B) I and III 1. When the client redeems his shares, he will not immediately know their dollar value. 3. If the client purchases the shares of two or more funds in the same family of funds, he may be entitled to a reduced sales charge.
A high net worth couple in their 40s earning a combined $480,000 annually have $100,000 they would like to conservatively invest. Given their income bracket, they stress reducing tax exposure and also note that having access to the funds is important. Which of the following would be the most suitable investment? A) Special situation mutual fund B) Municipal bond ETF C) Direct participation program D) GNMA fund
B) Municipal bond ETF Municipal bonds and GNMAs are the two conservative choices offered here. However, distributions of interest from the GNMA fund will be taxed at the federal, state, and local level. Income distributions from the municipal bond ETF will be tax exempt at the federal level, reducing tax exposure at their income level, and is the better choice. Direct participation programs are not conservative or liquid, and special situation mutual funds offer no reduced tax exposure. LO 8.g
Five years ago, the ABCD mutual fund bought 200,000 shares of Comet Industries at an average price of $42.25. After a series of accounting scandals, the shares are now trading at $6. If the fund decides to sell its shares, what will be the impact of the sale of Comet shares on the net asset value (NAV) of the ABCD fund? A) The NAV will fall B) The NAV will not change C) The NAV will rise D) This depends on whether the fund can claim a tax loss on the sale
B) The NAV will not change Portfolio holdings in a mutual fund are marked to the market each day. Therefore, the NAV of the fund already reflects the current value of each security in its portfolio, including Comet Industries. When the fund sells the position, the value of the stock is replaced by an equivalent amount of cash, so NAV does not change. LO 8.c
An investment adviser representative may describe dollar cost averaging to a customer as A) a form of a mutual fund withdrawal plan. B) a funding technique that will cause the average cost per share to be less than the average price per share. C) a means of purchasing more shares when share prices are high. D) a program for investing that will ensure profits even in a declining market.
B) a funding technique that will cause the average cost per share to be less than the average price per share. Dollar cost averaging is beneficial to the client because it achieves an average cost per share that is less than the average price per share over time. Using a fixed dollar amount each investment period, it enables the investor to purchase more shares when prices are lower and fewer shares when prices are higher. While dollar cost averaging does not ensure profits in any market or ensure against losses, it is an economical and convenient method for acquiring shares. LO 8.e
Mutual fund shareholders are often advised to enroll in automatic dividend reinvestment programs. In those programs, the investor can elect to have all distributions, or just those from income or just those from capital gains, automatically reinvested in additional shares of the fund. Among the advantages to the investor would be A) deferral of taxes until the shares are sold. B) automatic compounding of the investment. C) the additional shares are not subject to 12b-1 fees. D) the additional shares are purchased below the NAV.
B) automatic compounding of the investment. Similar in concept to the compounding of interest in a savings account, when distributions are reinvested rather than withdrawn, the capital has an opportunity to compound. Taxes are due in the year for which the distribution is paid (no tax break here). The shares are purchased at NAV; there are never cases where mutual fund shares are purchased below the NAV. If the fund has a 12b-1 charge, it would apply to the reinvested shares just as any other shares. LO 8.f
If a customer transfers his holdings from one fund to another within the same family of funds, what are the tax consequences? A) No gain or loss is recognized until redemption. B) Gains are taxed, and losses are deferred. C) On the transaction date, any gain or loss is recognized for tax purposes. D) Losses are deducted, and gains are deferred.
C) On the transaction date, any gain or loss is recognized for tax purposes. An exchange is a taxable event. The cost basis of the shares in the original account must be compared to their redemption value. Any gain or loss is recognized in the year of the exchange. The exchange privilege allows the investor to avoid paying an additional sales charge. It does not allow the investor to avoid taxes. LO 8.e
An investor reading the annual report of an investment company notices that among the company's expenses was the payment of interest on outstanding bonds. The company also paid dividends on preferred stock. This investment company is A) a balanced open-end mutual fund. B) a bond and preferred stock mutual fund. C) a closed-end management investment company. D) an exchange-traded fund.
C) a closed-end management investment company. It is the closed-end management investment company that is allowed to have bonds and preferred stock in its capitalization. Open-end investment companies (mutual funds and ETFs) can only issue one class of stock (common). Do not confuse an investment company's capitalization with the contents of its portfolio. LO 8.b
The public offering price for a mutual fund, as quoted in the financial press, reflects A) no sales charge because the offering price depends on the quantity purchased. B) the average sales charge for the preceding three months. C) the maximum sales charge the fund distributor collects. D) the minimum sales charge the fund distributor collects.
C) the maximum sales charge the fund distributor collects. The public offering price for a quoted mutual fund includes the maximum sales charge the fund distributor can assess. LO 8.c
A couple in a high tax bracket is interested in minimizing their tax liability while diversifying their portfolio. Which of the following best fits their investment objectives? A) Preferred stock B) Corporate convertible bonds C) GNMAs D) Tax-exempt unit trusts
D) Tax-exempt unit trusts Municipal unit trusts provide tax-free income to unit holders. Unit holders have an undivided interest in the underlying portfolio of municipal bonds. The trust consists of a number of different issues, and therefore has an element of diversification. LO 8.g
If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as A) a utilities fund. B) a growth fund. C) a closed-end company. D) a unit investment trust.
D) a unit investment trust. A unit investment trust issues shares that represent units of a particular portfolio; management has no authority—or only limited authority—to change the portfolio. The portfolio is fixed, not traded. LO 8.a
