BLACK - Investment companies
One of the goals of target date funds is to help manage A) investment risk. B) inflation risk. C) liquidity risk. D) retirement risk.
A. Although not always successful, target date funds adjust the asset allocation as the investor gets closer to retirement age (or whatever date is selected). In so doing, the goal is to reduce the overall investment risk. As mutual funds, liquidity risk is not a concern. In practice, they actually do not do a great job of managing inflation risk because the portfolio becomes heavily invested in fixed income as the target date approaches. This leaves the investor with little in the way of equities to protect against inflation. Retirement risk is not a term used in the industry.
Which of the following investors may not take advantage of breakpoints? A) Investment club B) Individual C) Trust D) Corporation
A. Breakpoint discounts are available only to legal persons. An investment club is not considered a legal person, but trusts and corporations are.
In which of the following markets would an investor expect to find closed-end investment company shares traded? I. A market maintained by the investment company itself II. The over-the-counter market III. The commodities market IV. The exchanges A) II and IV B) I and II C) I and III D) III and IV
A. Closed-end company shares are like ordinary stock. Once issued, they trade on exchanges or in the over-the-counter market. LO 8.c
The North American Perpetual Growth Fund's prospectus states that the fund meets the Investment Company Act of 1940's qualifications of a diversified management company. If the fund has net assets of $1 billion, A) no more than $300 million can be invested in the voting shares of any single issuer. B) no more than $250 million can be invested in the voting shares of any single issuer. C) no more than $50 million can be invested in the voting shares of any single issuer. D) no more than $100 million can be invested in the voting shares of any single issuer.
A. Diversified management companies must follow the 75-5-10 rule. That means, of 75% of the fund's net assets, no more than 5% of the fund's total assets can be in the voting shares of a single issuer. There are no restrictions on the other 25%; it can be invested as desired. Five percent of the $1 billion total is $50 million. The other 25% of the total assets ($250 million) can be invested in this stock without limitation. That makes the total possible investment into the voting shares of one issuer 30% of the total net assets or $300 million. LO 8.a
A customer seeks a significant long-term investment in the Ajax Fund, a growth-oriented mutual fund. To take advantage of breakpoints applicable to large investments, the customer should purchase A) Class A shares. B) Class B shares. C) Class C shares. D) Class D shares.
A. For initial purchases, breakpoints are only available if the customer purchases Class A shares, which are sold with a front-end load deducted from the initial investment. A substantial purchase can often reduce the sales charge to zero. Class B and Class C shares are sold with annual 12b-1 fees, as well as a contingent-deferred sales charge. Class D shares are sold with a level sales load plus a redemption fee.
Although investing in mutual funds has many advantages, there are some risks. One risk that is generally greater with a bond fund than a portfolio of individual bonds is A) interest rate risk. B) liquidity risk. C) default risk. D) purchasing power risk.
A. One disadvantage a bond mutual fund has is that there is no maturity date. At maturity, a bond returns the principal, regardless of what current market interest rates are. That is why as the bond approaches maturity, the interest rate risk declines (bonds with a shorter duration have less interest rate risk). The bond fund itself does not have that advantage because the fund does not mature. The risk of default is probably less with a bond fund because of the greater diversification than most individual portfolios can attain. The redemption at NAV feature of the mutual fund offers a liquidity that may not be available with some inactively traded individual bonds. Purchasing power risk would likely be similar in both cases. LO 8.i
An investor purchases 100 shares of a bond ETF at a price of $50 per share on September 5, 2019. On November 1, 2019, and February 1, 2020, the fund distributes a $0.50 per share dividend. On May 11, 2020, the investor sells all the shares at $57 per share. What are the 2020 tax consequences of the sale? A) Short-term capital gain of $700 B) Short-term capital gain of $700, dividend income of $50 C) Short-term capital gain of $600 D) Short-term capital gain of $700, interest income of $50
A. Taxation of the sale of an ETF is similar to that of a mutual fund. The question asks about the tax consequences of the sale, so we ignore the dividend distributions. Buying at $50 per share in September and selling at $57 per share the next May is a $700 capital gain over a period of less than one year. LO 8.i
In an effort to raise additional capital, which type of registered investment company may issue debt securities? A) A closed-end investment company B) A unit investment trust C) A face amount certificate company D) An open-end investment company
A. The capital structure of closed-end investment companies differs from other investment companies. Closed-end investment companies may issue debt securities, as well as preferred stock. Open-end companies and UITs can purchase debt securities for their portfolios but can only issue one class of equity.
When a mutual fund registers with the SEC under the Investment Company Act of 1940, it has the option to elect to be A) open-end or unit investment trust. B) diversified or nondiversified. C) an ETF. D) open-end or closed-end.
B. Mutual funds can be registered as diversified or nondiversified. The term mutual fund will always mean an open-end investment company. A closed-end company may be called a closed-end fund, but not a mutual fund. Although most ETFs are open-end investment companies, they are not mutual funds. LO 8.a
If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as A) a utilities fund. B) a closed-end company. C) a unit investment trust. D) a growth fund.
C. 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
An investor mentions the term level load fund shares to a registered representative. The investor is referring to A) Class A shares. B) shares of a closed-end fund. C) Class C shares. D) Class B shares.
C. Class C shares are referred to as level load because the charges never fluctuate. Shares are purchased at net asset value (no front-end load), and there is a back-end load (CDSC), generally for 12 months. The 12b-1 fees on Class C shares are higher than on Class A shares and remain so until the position is liquidated. Class C shares are most suitable for investors who will not maintain the position for the long term. LO 8.d
A stock mutual fund wishes to advertise itself as diversified. To be able to do so, the fund must invest its total assets, such that A) it holds no more than 10% of the voting stock of any one company. B) no more than 5% of its assets in any one company. C) at least 75% of its assets meet stated diversification requirements. D) its portfolio consists of at least 15 different stock holdings
C. The Investment Company Act of 1940 requires that a minimum of 75% of the assets of the diversified company meet stated requirements. Those requirements include the following: At least 75% of the fund's total assets must be invested in cash and securities that are not issued by the fund or any of its affiliates. Within that 75%, no more than 5% of the fund's total assets can be in a single stock. Within that 75%, no holding can represent more than 10% of the voting control of a single company. Please note that there are no restrictions on the nondiversified 25%. It can all be in a single stock. That means 30% of the fund's total assets can be in one company. Likewise, that 25% can be used to purchase a controlling interest in companies. LO 8.a
Which of the following investment companies is limited to offering investors a single class of common stock representing ownership in the company? A) A unit investment trust B) A face amount certificate company C) A closed-end management company D) A mutual fund
D. A mutual fund is an open-end management company that raises capital solely through the issuance of a single class of common stock. A face amount certificate sells interests in a pool of bonds that all mature on the same date. A unit investment trust is a fixed portfolio of debt or equity securities that sells redeemable units, not shares, to investors. Those units represent the investor's share in the trust's assets. A closed-end management company does a one-time IPO of common stock, after which its shares trade in the secondary market just like any corporate stock. Closed-end companies can also have a preferred stock issue and a bond issue. Please note: The term "single class" of stock is not related to the different classes for sales charge and expense purposes. Those classes merely define the costs the investor will incur to acquire and own the shares.
XYZ Technology Fund permits rights of accumulation. A shareholder has invested $9,000 and signed a letter of intent for a $15,000 investment. If his reinvested dividends during the 13 months total $720, how much money must he contribute to fulfill the letter of intent? A) $9,000 B) $5,280 C) $15,000 D) $6,000
D. As is often the case, there is information in the question that is irrelevant. In this case it is the statement about rights of accumulation. The question is about the letter of intent (LOI) signed by the investor in the fund. To meet the terms of the agreement, the shareholder must invest the full $15,000. With $9,000 already invested, an additional $6,000 must be invested to fulfill the terms of the LOI. Reinvested dividends and changes in the net asset value do not count toward a breakpoint during the period of a letter of intent but do count under rights of accumulation after the letter has been completed.
Which of the following statements regarding fixed municipal unit trusts are true? I. The trust is managed. II. The trust is not managed. III. The portfolio can be traded. IV. The portfolio cannot be traded. A) I and IV B) II and III C) I and III D) II and IV
D. Fixed unit trusts are not managed; the portfolio of securities does not change. As bonds mature or are called, the proceeds are distributed pro rata to the unit holders. These units are redeemable by the issuer or its agent. LO 8.a
A customer with an aggressive growth investment objective and short-term (6- to 12-month) time horizon wants to invest $50,000 in a mutual fund. He has a substantial net worth, but none of it is invested in mutual funds. You inform him that mutual fund investments are intended to be long-term investments, but he expresses his intention to make the short-term investment anyway. If the XYZ fund family (one you have dealt with in the past) offers an aggressive growth fund that has a respectable track record, your recommendation should be to A) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee. B) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee. C) decline the transaction because short-term trading of funds is not allowed. D) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in one year and 0.75% 12b-1 fee.
D. If the client insists on making this type of investment, then the Class C shares are most appropriate for this customer's objectives; the sales load would be lower than that of either Class A or Class B shares. LO 8.d
Unrealized gain in a mutual fund portfolio does which of the following? I. Increases the dividends paid to shareholders II. Represents the undistributed income and the growth in market value of securities held in the portfolio III. Is realized by shareholders only when they redeem their shares IV. Has no effect on shareholders until the annual long-term capital gains distribution is paid A) II and IV B) I and III C) I and IV D) II and III
D. Unrealized gains result from asset appreciation and undistributed income. This increase in value is reflected in an appreciation of the mutual fund shares. Investors realize this appreciation only by selling their shares. LO 8.c
Advertisements for the Abstemious Balanced Fund (ABF) describe the investment as a no-load fund. In order to make this claim, the fund must A) not have a front-end load in excess of 0.10% B) not have a 12b-1 charge in excess of 0.75% C) have its first breakpoint no higher than $10,000 D) not have a conditional deferred sales charge
D. When a fund promotes itself as a no-load fund, not only must there be no front-end load, there cannot be a back-end load (CDSC) either. The 12b-1 charge maximum is 0.25%. The concept of breakpoints applies solely to Class A shares (front-end load). LO 8.d
What are the tax consequences an investor incurs when exercising the conversion privilege within a family of funds? A) There are no tax consequences, as long as this is done through a Section 1035 exchange. B) There are no tax consequences because the funds are all part of one family. C) There are no tax consequences if completed within 60 days. D) The investor treats the exchange as a sale and new purchase.
D. When exchanging one fund for another in the same fund family, the exchange is done at NAV. This avoids any sales charges. The IRS considers this as the sale of the old fund (capital gain or loss applies) and the purchase of the new fund. That begins a new cost basis and holding period. The Section 1035 exchange allowing investors to move from one investment to another without current tax consequences is applicable only to insurance products.
Unit investment trusts differ from mutual funds in which two of the following ways? I. UITs have an expiration date; mutual funds do not. II. UITs generally have higher management fees than mutual funds. III. The portfolio of a UIT is fixed while that of a mutual fund changes as the managers look for investment opportunities. IV. UIT units are not redeemable while shares of mutual funds are. A) I and IV B) II and IV C) II and III D) I and III
D.When a unit investment trust is formed, there is a pre-determined expiration date. In the case of a trust containing debt securities, the trust expires when the securities mature. In the case of an equity trust, the date is fixed. There is no management fee because there is no ongoing management of a fixed portfolio. Both UITs and mutual funds issue redeemable securities. LO 8.a
