Unit 8

Investment advisory and underwriter contracts must have in writing:

- precisely describe all compensation to be paid -will be approved at least annually by the BOD or by majority vote of the shareholders if it is to be renewed after the first 2 years -provides that it may be terminated at any time, without penalty, by the BOD or by majority vote of the shareholders on not more than 60 days' written notice to the investment adviser.

Right of accumulation differences from LOI

-Allows the investor to use prior share appreciation and reinvestment to qualify for breakpoints -Do not impose time limits

Mutual fund risk

-Market risk -Interest-rate risk -net redemptions -Expense risk -Tenure risk

CEF risks

-Pricing risk -Leverage risk

Anti-reciprocal Rule

A rule created by the Financial Industry Regulatory Authority (FINRA) to protect individual investors from conflicts of interest that may arise when brokerage firms and mutual funds collaborate.

Global funds

Both U.S. and foreign countries. Just to diversify.

Stock funds

Common stock is usually found in the portfolio of any mutual fund that has growth as a primary or secondary objective. Equity funds have historically outpaced inflation over most 10 year time horizons.

Mutual fund

Doesn't specify the exact # of shares it intends to issue. It registers an open offering w/ the SEC. Can raise an unlimited amount of investment capital by continuously issuing new shares. only issue common stock.

Expense ratio

Expresses the management fees and operating expenses as a % of the fund's net assets. All mutual funds, load and no-load, have expense ratios.

FINRA- Noncash compensation

Gifts of material value not to exceed $100 per person per year may be given, as well as occasional meals/tickets to sporting events or entertainment. Attendance at a training or educational meetings may be sponsored with records ofc, but guests are not reimbursed.

ETFs vs. Index mutual funds (short selling)

Index ETFs can be sold short at any time during trading hours.

ETFs vs. Index mutual funds (Intraday trading)

Intraday trading:investors don't have to wait until the end of a trading day to purchase or sell shares. ETF shares trade and are priced continuously throughout the day, making it easier for investors to react to market changes.

Balanced Funds (hybrid funds)

Invest in stocks for appreciation and bonds for income.

Diversified management company

Under the investment company act of 1940; meets the requirements of the 75-5-10 test: -at least 75% of the fund's total assets must be invested in cash & securities issued by companies other than the investment company itself or its affiliates. -the 75% must be invested in such a way that -no more than 5% of the fund's total assets are invested in the securities of any one issuer -no more than 10% of the outstanding voting securities of any one issuer is owned (by the 75%)

Unit investment Trusts (UITs)

Unmanaged investment company organized under a trust indenture. They do not: -have boards of directors -employ an investment adviser -actively manage their own portfolios only issues redeemable securities units or shares of beneficial interest.

Front-end loads (Class A shares)

are paid to the mutual fund company when you first purchase the fund. Up to 8.5% of the money invested.

Corporate Bond Funds

have higher credit risk than various government issues but can still be classified as investment-grade or risker portfolios.

Mid-cap funds

somewhat less aggressive and have in their portfolio shares of companies with a market cap of b/t $2 billion and $10 billion.

Non-qualified dividends

taxed as ordinary income.

Qualified dividends

taxed at the lower long-term capital gains rate.

Test topic alert for diversified management companies

the 5% and 10% limitations are part of the 75% invested. There are no conditions attached to the remaining 25%.

No-Load funds

-Charges redemption fees. -fees cannot exceed 0.25% of the fund's average annual net assets.

Money market funds

-NO LOAD -Open End Mutual Funds -serve as temporary holding account for cash -primary objective is liquidity -dividends change often (amount, frequency) -dividends computed daily, credited monthly -check writing privileges -price fixed at $1 per share and does not fluctuate with interest rates

Class C shares

-No front load -back load 1% but drops to 0 after 1 year -12b-1 is .75% for life of account -medium expense ratio -no breakpoints, etc. -no conversion -Low amount investor, short time

Breakpoint considerations:

-No standard breakpoint schedule -Mutual funds must disclose their breakpoint schedule in prospectus -SEC encourages the breakpoint schedule info to be accessible for people -Discounts can happen if there's a large single investment, a series of aggregated investments or promise to invest via LOI -Purchases must be made by same investor to qualify for breakpoint discount -Shares purchased in the same fund family are eligible to be aggregated together for discount

MSRB Rule G-20 (Gift Rule)

-Prohibits any member/person associated with a member, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment is in relation to the business of the recipient's employer. There is no limit on the gifts/compensation that may be given to employees, as long as it isn't designed to reward or influence the sale of specific products.

Prohibited activities-Mutual funds cannot:

-Purchase any security on margin -participate on a joint basis in any trading account in securities (an investment company cannot have a joint acct w/someone else) -sell any security short -acquire more than 3% of the outstanding voting securities of another investment company

UIT Risk

-market risk -Interest-rate risk

Eligibility on breakpoints:

-married couples -parents w/minor children -corporations -Parents combined w adult children are NOT eligible.

ETF benefits

-taxation -expense ratio (low) -portfolio specificity -exchange-traded -leveraged and inverse ETFs

Interval funds

-these are closed-end investment companies, registered as such under the Investment Company Act of 1940. -Unlike other closed-end funds, interval funds don't trade in the secondary market. -can be monthly/annually, investors are allowed to sell a portion of their shares back to the funds at NAV. -Portfolio manager can take certain illiquid positions a mutual fund manager might not take -more suitable for long term investors.

UIT Benefits

1. Income 2. Liquidity 3. Rolling over proceeds 4. CEF benefits 5. Exchange-traded 6. Pricing 7. Leverage

Expect questions about 12b-1 fees:

1. The 12b-1 fee is expressed as an annual amount but is charged & reviewed quarterly. 2. Charges covered by 12b- fees include advertising, sales literature, and prospectuses delivered to potential customers, not fund-management expenses. 3. In order for a fund to market itself to the public as a no-load fund, the fund may not charge more than 0.25% of avg net assets for 12b-1 fees. 4. The max allowable 12b-1 charge under FINRA rules is 0.75% (75 basis pts) 5. FINRA does permit an additional 0.25% charge for shareholders' services (25 basis pts) but that is treated separate from the 12b-1 fee for marketing and promotion.

Remember for index ETFs:

1. asset allocation 2. following industry trends 3. balancing a portfolio 4. speculative trading 5. hedging

The investment company act of 1940 classifies investment companies into 3 broad types:

1. face amount certificate 2. unit investment trusts 3. management investment companies

Major fund categories:

1. stock funds invest in stocks 2. Bond funds invest in bonds 3. Balanced funds invest in a combination of stocks and bonds 4. Money market funds invest in very short-term investments.

To have the exchange take place with no-load, the following rules apply:

1. the purchase may not exceed the proceeds generated by the redemption of the other fund. 2. the redemption may not involve a refund of sales charges. 3. the sales personnel and dealers must receive no compensation of any kind from the reinvestment.

Face-amount certificate (FAC)

A contract between an investor and an issuer in which the issuer guarantees payment of a stated (fixed) sum to the investor at some set date in the future. In return for this future payment, the investor agrees to pay the issuer a set amount of money like a lump sum or installments.

Investment company

A corp. or a trust through which investors may acquire an interest in large, diversified portfolios of securities by pooling their funds with other investors' funds and buying shares or units of the fund.

Backdating the letter

A fund often permits a customer to sign a LOI as late as the 90th day after an initial purchase. but may not cover more than 13 months in total. A customer who signs the LOI 60 days after a purchase has 11 months to complete the letter.

Open-end (mutual funds)

A mutual fund's POP is the NAV per share plus any applicable sales charge. A mutual fund's NAV is calculated daily by deducting the fund's liabilities from its total assets.

Letter of intent (LOI)

A person who plans to invest more money w/the same mutual fund company. It will receive a decrease in his overall sales charges. The investor informs the company that he intends to invest the additional funds necessary to reach the breakpoint within 13 months.

Rights of Accumulation

A privilege that allows mutual fund shareholders to receive sales charge discounts based on the current value of their investment in a fund or all funds in a family

Business Development Company (BDC)

Aids small businesses. Closed-end investment company regulated under the Investment Company Act of 1940. Isn't like the regular closed-end funds b/c at least 70% of its assets must be invested "eligible" assets.

Exchange privileges

Allow an investor to convert an investment in one fund for an equal investment in another fund in the same family

Regulated investment company

An investment company to which Subchapter M of the Internal Revenue Code grants special status that allows the flow-through of tax consequences on a distribution to shareholders. If 90% of its income is passed through to the shareholders, the company is not subject to tax on this income.

Quiz question: Which of the following statements correctly expresses requirements under the Investment Company Act of 1940? A. A registered open-end investment company using a bank as custodian must choose one that has FDIC coverage. B. Shareholders must receive financial reports from the fund at least annually. C. No investment advisory contract may be entered into that does not provide for termination with no more than 60 days' notice in writing. D. No open-end investment company may offer shares to the public unless the fund has capital of at least $1 mill.

C.

closed-end investment company

Does an initial offering, registers a fixed # of shares w/the SEC, and offers them to the public for a limited time through an underwriting group. Investors can't redeem their shares back to the company. Just has to sell them in the secondary market. ' issues common stock, preferred stock, and bonds.

Value funds

Focuses on companies whose stocks are currently undervalued. These undervalued companies are expected to perform better than reporters indicate.

Net Investment Income (NII)

Includes gross investment income, dividend and interest income from securities held in the portfolio minus operating expenses.

Bond funds

Income is the main objective. Some funds invest solely in investment-grade corporate bonds. Others seek safety, invests only in govt issues. Still others want to max their current income by investing in lower-rated junk bonds for higher yield.

ETFs vs. Index mutual funds (margin eligibility)

Index ETF shares can be purchased on margin, subject to the same terms that apply to common stocks.

Cost of entry

Initial investment as low as $1,000. Once the account is opened, additional investments can be made w/little as $25.

Growth/Value funds

Invests in stocks of companies whose businesses are growing. These funds are focused on generating capital gains rather than income.

ETF

It registers with the SEC under the Investment Company Act of 1940 either as a unit investment trust or as an open-end management company.

FINRA rules - selling dividends

It's prohibited to induce customers to buy mutual fund shares by implying that an upcoming distribution will benefit them. What is usually not explained is that the NAV of the fund will drop by the amount of the dividend.

test topic alert: An investor purchases shares of a mutual fund. 3 months later, the fund has a long-term capital gains distribution. This would be taxed as what?

Long-term capital gain. It makes no difference how long the investor held the fund shares; this is a distribution of the fund's long-term gains being passed through to the investor. When he sells it, then the holding period is important.

Large-cap funds

Market cap of greater than $10 billion. The lower the market cap, the greater the volatility.

Index funds

Mirrors a market index. It buys and sells securities that reflects the selected index.

Net Investment income formula

NII=Dividends + interest - expenses of the fund D+I-E

Principal-protected funds

Offer investors a guarantee of principal, adjusted for fund dividends and distributions, on a set future date while providing opportunities for higher returns through investment in higher risk and higher expected return asset classes such as equities.

Computing the Sales Charge Percentage

POP - NAV = sales charge ($ amount) Sales charge ($ amount)/ POP = sales charge % NAV/ 100% - sales charge % = POP

FINRA Rule 2341

Prohibits its members who underwrite fund shares from assessing sales charges in excess of 8.5% of the POP on the purchase of open-end investment company shares.

High-yield bond funds

Provide the highest yields due to their increased credit risk and are considered speculative investments.

Level loads (asset-based fees) class C shares

Provide trail commissions to the registered rep servicing the account

Investment Company Act of 1940

Provides for SEC regulations of investment companies and their activities.

Pricing of closed-end company

Publicly traded funds. After the stock is distributed, anyone can buy/sell shares in the secondary market, either on exchange or OTC. -Supply and demand determines the bid price & ask. -Closed-end fund shares usually trade at a premium or discount to the shares' NAV.

Form 1099-DIV

Sent to shareholders after the close of the year, details tax information related to dividend distributions for the year. This allows investor to enter the proper info on their Form 1040.

Class B shares

Shares of a mutual fund that generally assesses a contingent deferred sales charge if the shares are sold within a certain period. Class B shares generally have higher 12b-1 fees than Class A shares.

small-cap funds

Some of these funds invest in newer companies with relatively small cap (less than $2 billion cap)

Some mutual fund families offer a conversion privilege that permits conversion from the shares of one fund to the shares of another fund in the same family at the current NAV per share.

The conversion privilege is also called exchange privilege. Conversion from bond/preferred stock to common isn't a taxable, but from one fund to another is considered a sale and new purchase. If the old shares have appreciated, there would be a taxable capital gain.

FINRA rules - Sales agreement

The firm must have a written sales agreement with the investment company. -no member firm may purchase mutual fund shares from a client at a price lower than the NAV next quoted for the shares. -broker-dealers cannot receive compensation on the sale of shares that are quickly redeemed.

Qualification for customers for rights of accumulation

The mutual fund generally bases the quantity of securities owned on the higher of current NAV or the total of purchases made to date.

Breakpoints

The schedule of quantity purchase discounts a mutual fund offers. Includes: -married couples -parents and their minor children -corporations

TEST TOPIC ALERT ON CLOSED END-FUNDS

They trade in the secondary market (exchange/OTC). That makes their price based upon supply and demand for their shares. Their buying and selling price doesn't have a direct relationship to the NAV of the shares.

Net asset value

This value is the result of the fund valuing all of its assets (the largest of which is the portfolio), subtracting its liabilities, and then dividing that by the # of shares outstanding. it's critical to the purchase and sale of open-end companies.

12b-1 asset-based fees

Used to cover the costs of marketing and distributing the fund to investors. -Used to compensate registered reps for servicing an account but shouldn't be confused with sales charges. -The fee is deducted quarterly as a % of the fund's avg total NAV. MAX fee is 0.75% for distribution and promotion.

Dollar cost averaging

Where an investor invests identical amounts at regular intervals. This form of investing allows the individual to purchase more shares where prices are low, and fewer shares when prices are high.

Breakpoint sale

Where registered representatives try to seek higher commissions by selling investment company shares in a dollar amount just below the point at which the sales charge is reduced.

Fixed-dollar

Where the fund liquidates enough shares each period to send that sum. The amount of money liquidated may be more or less than the account earnings during the period.

Management investment company

actively manages a securities portfolio to achieve a stated investment objective. Either closed-end or open-end. Mutual funds are open-end. only difference b/t open and closed is how they raise capital and how investors can buy/sell shares.

Voluntary accumulation plan

allows a customer to deposit regular periodic investments on a voluntary basis. They can discontinue the plan anytime.

Leveraged ETFs

attempt to deliver a multiple of the return of the benchmark index they're designed to track. Ex. a 2x leveraged fund would try to deliver two times the return of whatever its tracking. There's no limits by rule or regs as to the amount of leverage that would be applied.

Inverse funds

attempt to deliver returns that are the opposite of the benchmark index they're tracking. So if the benchmark is down 2%, the fund's goal is to be up 2%. Can be leveraged fund, just have a bearish attitude.

Target date funds

attempt to maintain a desirable balance of risk and growth potential based on a target retirement date. It can gradually reduce risk by changing the investments within the fund to a more conservative mix as the target date approaches. DOES NOT PROVIDE GUARANTEED INCOME.

Asset Allocation Funds

invest in various asset classes, such as stocks, and bonds, with precise amounts within each type

International funds

invests only in the securities of foreign companies. Long-term capital appreciation is their primary objective.

ETFs/leveraged

resets daily, meaning they're designed to achieve their stated objective on a daily basis. not good for long-term.

Blend/core funds

stock funds with a portfolio comprised of a number of different classes of stock allows investors to diversify their investment via management and seqs in a single fund

Back-End Load (Class B Shares)

when funds are withdrawn. Some funds charge ongoing fees under section 12b-1 of the Investment Company Act of 1940.