Unit 8 Checkpoint Exam

Parents planning to save for their children's education would probably find all of these suitable except A. money market mutual funds. B. Treasury STRIPS. C. Coverdell ESAs. D. Section 529 plans.

A. money market mutual funds. Although money market mutual funds are safe investments, they offer no potential growth of capital and provide low income. The 529 and ESA plans offer tax benefits and investment options that can provide the necessary growth. The Treasury STRIPS are the safest zero-coupon securities available and promise a definite return until maturity.

Many mutual fund investors elect to reinvest their dividends into additional shares of the fund. When an investor does this with dividends paid by a common stock fund, A. the dividends are taxable in the year received. B. the additional shares are purchased at the public offering price. C. the investor's cost basis is reduced by the amount of the dividend. D. they are tax free until the shares are sold.

A. the dividends are taxable in the year received. Unlike dividends from a municipal bond fund or UIT, which are exempt from federal income tax, dividends from stock funds (or taxable bond funds) are taxable in the year paid, regardless of whether they are reinvested or taken in cash. The test wants you to know that there is no tax advantage to reinvesting distributions. There are other benefits, such as reinvestment at NAV instead of POP, but tax breaks is not one of them. As it happens, when dividends are reinvested, the investor's tax basis increases by the amount of the dividend.

Probably the most significant difference between a business development company (BDC) and any other investment company registered under the Investment Company Act of 1940 is that a BDC A. qualifies for special tax treatment by distributing at least 90% of its net investment income to owners. B. makes available significant managerial assistance to the investments in their portfolio. C. is required to file annual reports with the SEC. D. issues shares that trade actively in the secondary markets.

B. makes available significant managerial assistance to the investments in their portfolio. All other registered investment companies are passive investors. That is, they do not take an active role in the management of the companies held in their portfolios. The purpose behind BDCs is just that - help small companies with management issues. BDCs, like most other investment companies, qualify as regulated investment companies by distributing at least 90% of their net investment income. Doing so enables them to avoid tax on the distribution. Like closed-end funds and ETFs, shares of BDCs trade actively in the secondary markets. Many trade on the NYSE and the Nasdaq Stock Market, while others trade OTC. As do all registered investment companies, BDCs file annual reports with the SEC.

Your customer owns a leveraged ETF, having a performance goal of 200% of the underlying index. When purchased two weeks ago, the ETF was priced at 50. If the index was up 10% the first week and down 20% the second week, what is the value of the ETF today if it performed as it was intended to? A. 45 B. 44 C. 36 D. 40

C. 36 Priced at 50 when purchased, after the first week's 10% increase in the index, the 2× leveraged ETF would be up 20% (20% × 50 = 10 point increase) to 60. After the second week's 20% decline in the index, the 2× leveraged ETF would be down 40% (40% × 60 = 24 point decrease) to 36.

If a couple has a long-term growth objective and is willing to accept a reasonable amount of risk, which of the following mutual funds is most suitable for them? A. Corporate bond fund B. Municipal bond fund C. Common stock fund D. Money market fund

C. Common stock fund A common stock fund will help the couple meet their long-term growth objective.

Which of the following statements best describes the effect of reinvesting mutual fund distributions? A. Dividends from investment income that are reinvested have tax-deferred status. B. Capital gains that are reinvested have tax-deferred status. C. The reinvestment of capital gains and dividends results in a higher cost basis. D. The reinvestment of capital gains and dividends has no effect on cost basis.

C. The reinvestment of capital gains and dividends results in a higher cost basis. Because reinvested distributions are taxed in the year received, the investor's cost basis is increased by the amount of the distribution. This is to prevent those distributions from being taxed twice. They are taxed once as the dividend or capital gain and then, if not added to the cost basis, would be taxed a second time when the shares are sold. Reinvestment of these distributions does not avoid or defer current taxation. This is not the same as receiving a stock dividend where the taxes are deferred until those shares are sold.

What investment company, structured as a closed-end management company under the Investment Company Act of 1940, must have at least 70% of its assets invested in eligible securities? A. Hedge funds B. Private equity funds C. Venture capital funds D. Business development companies

D. Business development companies A business development company (BDC) is a closed-end investment company regulated under the Investment Company Act of 1940. It does not have the flexibility of regular closed-end funds because at least 70% of its assets must be invested eligible assets. It is highly unlikely that the exam will test on the specifics of eligible portfolio assets (some details are in the LEM). None of the other choices is a registered investment company under the Investment Company Act of 1940.

An investment company registered under the Investment Company Act of 1940 that allows shareholders to sell their shares back to the company at the net asset value per share only at certain specified times is A. a closed-end investment company. B. a unit investment trust. C. an open-end investment company. D. an interval fund.

D. an interval fund. The unique characteristic of an interval fund is that at certain specified intervals, shareholders are able to sell their shares back to the fund at NAV. True, these are closed-end investment companies, but on the exam, you always need to choose the most specific answer. Open-end investment companies (mutual funds) and unit investment trusts (UITs) permit redemption at NAV on a continuous basis, not at specified intervals.