S7 UNIT 7 Quizzes (Investment Companies)

An investor redeems 200 shares of ABC Fund, which has no redemption fee. If the quote is $12.05 bid $13.01 asked, what amount will the investor receive? A) $1,098.00 B) $2,410.00 C) $2,275.50 D) $2,602.00

B) $2,410.00 Explanation If a mutual fund has no redemption fee, the investor will receive the bid price per share (net asset value) multiplied by the number of shares being redeemed. In this case, the investor would receive $2,410 ($12.05 × 200 shares). LO 7.c

Mutual funds have several different methods for assessing charges to become shareholders. One of those is the front-end load and is charged when purchasing A) Class C shares. B) Class A shares. C) Class B shares. D) Class D shares.

B) Class A shares. Explanation Purchasers of Class A shares pay a sales charge on each investment. Because the sales charge comes off the amount invested, it is called a front-end load. Class B and C shares have back-end loads, although Cs usually drop off after one year. LO 7.d

If a customer submits a redemption order to her broker-dealer after the close of the New York Stock Exchange, she will receive a price based on the net asset value computed A) the same day, regardless of when the order is received. B) the next time the fund computes it. C) the previous business day. D) within the next two business days.

B) the next time the fund computes it. Explanation Orders to redeem shares are executed at the next computed price. This is an example of the forward pricing rule. LO 7.c

A member or person associated with a member may give gifts of material value as well as occasional meals or tickets to sporting events or other entertainment. The FINRA limit per person per year is A) $250. B) $200. C) $100. D) $500.

C) $100. Explanation Gifts of material value are not to exceed $100 per person per year. There are exceptions to this, which may not be preconditioned on the achievement of a sales target. LO 7.j

A money market mutual fund would be least likely to invest in which of the following assets? A) Bank certificates of deposit B) Repurchase agreements C) U.S. Treasury notes D) U.S. Treasury bills

C) U.S. Treasury notes Explanation A money market mutual fund typically invests in money market instruments or those with a maturity date not exceeding 397 days. Treasury notes have maturity dates of 2-10 years. LO 7.g

Money market mutual funds are highly recommended for those who A) are accumulating funds for retirement in 20 years. B) wish to save for college for their 10-year-old child. C) have a specific need for funds within the next six months to a year. D) are aggressive investors looking for quick returns.

C) have a specific need for funds within the next six months to a year. Explanation Money market mutual funds are like having cash in the bank. The returns are very low, but the safety and liquidity are very high. They are the perfect investment for parking money for the short term. Other than a small portion, perhaps 5%‒10% of the total portfolio, money market fund shares are generally not recommended for long-term investing. LO 7.g

All of the following might be found in a money market fund's portfolio except A) T-bills. B) banker's acceptances. C) negotiable CDs. D) common stock.

D) common stock. Explanation A money market mutual fund portfolio will consist of money market instruments, which are short-term, high-quality debt securities. They include treasuries with less than one year to maturity and negotiable CDs. Because common stock is equity, it is not found in money market funds. LO 7.g

When reviewing a money market fund portfolio, one would not expect to find A) T-bills. B) T-bonds with less than one year to maturity. C) negotiable CDs. D) common stock.

D) common stock. Explanation Money market instruments are short-term, high-quality debt securities. This includes treasuries with less than one year to maturity and negotiable CDs. Because common stock is equity, it is not found in money market funds. LO 7.g

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 and income fund B) An index fund C) A growth fund D) An income fund

Explanation 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 7.g

If you invest in a front-end load mutual fund and choose automatic reinvestment, you should expect that I) dividend distributions will be reinvested at net asset value. II) dividend distributions will be reinvested at the public offering price. III) capital gains distributions will be reinvested at net asset value. IV) capital gains distributions will be reinvested at the public offering price. A) I and III B) I and IV C) II and IV D) II and III

A) I and III Explanation Mutual funds that offer automatic reinvestment of dividends and gains distributions must do so at net asset value. LO 7.f

What are the tax consequences an investor incurs when exercising the conversion privilege within a family of funds? A) The investor treats the exchange as a sale and new purchase. B) There are no tax consequences if completed within 60 days. C) There are no tax consequences as long as this is done through a Section 1035 exchange. D) There are no tax consequences because the funds are all part of one family.

A) The investor treats the exchange as a sale and new purchase. Explanation 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. LO 7.i

Mutual fund Class B shares assess A) a deferred sales load. B) a level load. C) no load. D) a front-end load.

A) a deferred sales load. Explanation Class B shares carry a deferred sales load. This is sometimes referred to as a back-end load. Class A shares carry a front-end load. Class C shares charge a 12b-1 fee quarterly with a small back-end load in the first year. LO 7.d

An investor's portfolio contains a number of different securities. Included are equity and debt positions in several business development companies (BDCs). It would be correct to state that A) distributions from the equity BDC positions are treated as dividends while those from the debt positions are interest. B) distributions from both BDC positions are treated as dividends. C) distributions from both BDC positions are treated as interest. D) distributions from the equity BDC positions are treated as a return of capital while those from the debt positions are interest.

A) distributions from the equity BDC positions are treated as dividends while those from the debt positions are interest. Explanation A BDC (business development company) is a specialized type of closed-end investment company. As such, it can issue debt securities as well as equity. Most operate as regulated investment companies (RICs) under the Internal Revenue Code. Being a RIC requires distributing at least 90% of the company's net investment income. This, just as with other investment company distributions, is treated as a dividend. When the BDC issues a debt security, just as with other debt securities, interest is paid to the lenders. LO 7.b

All of the following must be sold with a prospectus except A) an IPO of common stock. B) closed-end funds in the secondary market. C) closed-end funds in the primary market. D) open-end funds in the primary market.

B) closed-end funds in the secondary market. Explanation Securities sold in the secondary market do not have a prospectus delivery requirement. LO 7.c

A customer wishes to redeem 1,000 shares of a mutual fund. The net assets value (NAV) and public offering price are $10, and a redemption fee of 0.5% will be charged. How much will the customer pay in redemption fees? A) $9,950 B) $500 C) $50 D) $9,500

C) $50 Explanation The question did not ask how much he would receive upon redemption, but how much he would pay in redemption fees. Mutual fund shares are redeemed at the NAV (bid): 1,000 shares times $10 each equal $10,000. $10,000 × 0.005 (0.5% redemption fee) = $50. LO 7.d

Investing into mutual fund Class A shares will result in a customer paying a sales charge that is imposed at the time of purchase. That is why these shares are called front-end load shares. With Class A shares, the investor might be entitled to breakpoints resulting in the customer paying a reduced sales charge based on a breakpoint schedule found in the prospectus. Purchases by which of the following can be combined to reach breakpoints? A) A parent and adult child B) A parent and dependent adult child C) A married couple D) An investment club

C) A married couple Explanation The accounts of married couples are eligible to be combined to reach breakpoint levels. Also eligible are parents with minor children. Parents with adult children are not eligible, even if the child is a dependent, and investment clubs are specifically mentioned in the law as not eligible. LO 7.d

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) is required to file annual reports with the SEC. B) qualifies for special tax treatment by distributing at least 90% of its net investment income to owners. C) makes available significant managerial assistance to the investments in their portfolio. D) issues shares that trade actively in the secondary markets.

C) makes available significant managerial assistance to the investments in their portfolio. Explanation 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 to 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. LO 7.b

All of the following would be found in the money market except A) repurchase agreements. B) Treasury bills. C) preferred stock. D) commercial paper.

C) preferred stock. Explanation The money market consists of short-term, high-quality debt instruments. This would not include preferred stock, which is an equity instrument. LO 7.g

A retired person seeking to maximize income with reasonable safety and liquidity should most likely consider investing in A) a large-cap growth fund. B) a long-term government bond fund. C) an intermediate-term government bond fund. D) an intermediate-term, high-grade corporate bond fund.

D) an intermediate-term, high-grade corporate bond fund. Explanation In all these cases, liquidity should not be a problem because mutual funds have a seven-day redemption requirement. However, interest rate risk increases as the maturities lengthen, so the intermediate-term portfolios offer that benefit, albeit at a slight reduction in income. The high-grade corporate bonds will offer a greater return with slightly more risk than the government bonds. If the question had said the investor wished to minimize risk, then the government bond fund would have been a better selection. LO 7.g

In general, management investment companies, either open end or closed end, must have a board of directors that consists of A) more than 60% interested persons as directors. B) at least 40% meeting the definition of interested persons as directors. C) more than 60% noninterested outside directors. D) at least 40% noninterested outside directors.

D) at least 40% noninterested outside directors. Explanation At least 40% of a board of directors must be noninterested, that is, outside directors. These individuals have no connection to the fund other than a position on the board. They may own some shares of the fund, as would any investor. At most, 60% of the directors may be interested persons. LO 7.j

One respect in which the capitalization of a closed-end investment company differs from an open-end investment company is that the closed-end company A) can continuously issue new shares. B) can invest in senior securities. C) trades at a price based on supply and demand. D) can issue senior securities.

D) can issue senior securities. Explanation Under the Investment Company Act of 1940, only the closed-end company has authorization to issue senior securities (preferred stock and bonds). Open- and closed-end companies can invest in senior securities if appropriate to their investment objectives. Only the open-end company has a continuous offering of new shares (open vs. closed). Although it is true that the price of a closed-end company is based on supply and demand, that is not part of the company's capitalization. Be sure to answer the question being asked. LO 7.b

One way in which open-end investment companies differ from closed-end investment companies is that open-end companies A) are suitable for inclusion in IRAs. B) are limited to a single class of equity in their portfolio. C) may be diversified or nondiversified. D) use forward pricing to determine their redemption value.

D) use forward pricing to determine their redemption value. Explanation Price determination for purchases and sales of mutual funds is based on the forward pricing principle. That is, whenever an order to purchase or redeem shares is received, the price is based on the next computed NAV per share. In the case of closed-end companies, they trade in the secondary markets at prices determined by supply and demand. Those prices may have little resemblance to the fund's NAV. Both open- and closed-end companies have the option to be diversified or nondiversified. Open-end companies are limited to one class of capital issue, but how they invest the money raised from that issue is up to the portfolio manager. Open-end and closed-end funds are both suitable investments for retirement plans. LO 7.c

A customer of your broker-dealer is bullish on U.S. equity securities across a broad spectrum of industries. He would like to participate in an anticipated upward movement of an equity stock index. Which of the following investments would you recommend as being closely related to the movement of equities in general? A) American depositary receipts (ADRs) B) Standard & Poor's depository receipts (SPDRs) C) Variable rate demand obligations (VRDOs) D) Real estate investment trusts (REITs)

B) Standard & Poor's depository receipts (SPDRs) Explanation The SPDR is an index fund designed to replicate and track the performance of the S&P 500, a broad-based equity index. LO 7.h

Certain events will affect the net asset value (NAV) per share of a mutual fund. Which of the following events will not affect NAV? A) The fund receiving cash dividends on the securities in its portfolio B) The fund paying dividends to its shareholders C) Fund shares being redeemed by the fund upon the request of shareholders D) The value of the fund portfolio's securities fluctuating

C) Fund shares being redeemed by the fund upon the request of shareholders Explanation Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. Although share redemption will reduce total NAV, the number of shares outstanding decreases in proportion, so the NAV per share stays the same. LO 7.c

Which of the following investments is the most liquid? A) Foreign stock mutual funds B) Common stock traded on the New York Stock Exchange C) Money market mutual funds D) Variable annuities

C) Money market mutual funds Explanation When an asset is liquid, the owner can quickly turn it into cash. If you need money to pay bills today or you are going shopping, you need a high degree of liquidity. Let's look at the answer choices. Mutual funds of any type must comply with federal law requiring them to honor a redemption request at the next computed net asset value per share. Then, those proceeds must be sent within seven days. If the bill collector is at your door or the sale ends today, that's not quickly enough. The same federal law applies to the variable annuity. Listed stock has great liquidity, but in most cases, settlement is T+2 meaning you'll have to wait a couple of days to get the money. Even if the sale was made in what is called "delivery for cash" (same day settlement), you'll have to wait for the check from the broker-dealer or make the trek to the office. Even then, the funds won't generally be available to the investor until the next business day. On the other hand, when it comes to the money market mutual fund, invariably, you have a checkbook, no different from the checkbook at your bank. That means, if you have to pay the bill collector today or take advantage of the last day of a sale, you simply write a check. There is no investment that gets you your money faster than that. LO 7.g

If you were reading sales literature about a mutual fund that claimed its objective is to be a single source investment for most equity investors, it would most likely be describing A) a growth/income fund. B) a target date fund. C) a blend/core fund. D) a specialized fund.

C) a blend/core fund. Explanation A blend/core fund combines equities with different market characteristics. There are stocks fitting a growth style and others with a value style. It will include some high quality blue-chip stocks and some on the other end of the risk spectrum. Target date funds have different portfolios for each targeted date and will include both equity and fixed income securities. The portfolio of a growth/income would have much overlap with that of a blend/core fund, but more emphasis is placed on including stocks for their dividend payout. A specialized fund would concentrate in either a specific geographic area or industry and is not going to be recommended as the only fund for the investor's portfolio. LO 7.g

The capitalization structure of an open-end investment company can include A) preferred stock, common stock, and bonds. B) only debt issues with no bank borrowing allowed. C) one issue of common stock. D) preferred and common stock with no bank borrowing allowed.

C) one issue of common stock. Explanation Open-end investment companies may only issue shares of common stock. Preferred stock, bonds, and other forms of senior securities are not allowed. It is the closed-end investment company that can have a preferred stock and bond offering. Don't confuse what a mutual fund uses to raise money (the common stock it issues) with what it does with that money. The capital raised from the sale of shares may be used to buy whatever securities meet the fund's objectives. LO 7.b

One of your customers has been regularly investing into the shares of an aggressive growth fund. The investor has a long time horizon and does not expect to touch the account for a number of years. In the event of an emergency, federal law would require redemption proceeds forwarded within A) 30 calendar days. B) 2 business days (T+2). C) 4 business days (S+2). D) 7 days.

D) 7 days. Explanation One of the provisions of the Investment Company Act is that redemption requests must be honored within 7 days. LO 7.i

Which of the following would not be a suitable recommendation to an investor with a liquidity constraint? A) An interval fund B) An open-end fund C) A closed-end fund D) A unit investment trust

A) An interval fund Explanation Interval funds do not trade in the secondary market. Shares may only be redeemed at the specified intervals and, even then, only a portion of the holding will be repurchased by the issuer. Closed-end funds are publicly traded and open-end funds and UITs offer daily redemption at NAV. LO 7.b

A 2× leveraged inverse ETF tracks an index that recently fell 2%. If the ETF was priced at $25 per share before the drop in the indices price, where should the ETF be priced now, assuming the ETF portfolio performed as intended? A) Up $1 per share B) Down $1 per share C) Down $2 per share D) Up $4 per share

A) Up $1 per share Explanation An inverse fund portfolio attempts to mirror returns that are the opposite of the index it is tracking. Therefore, if the index falls, this ETF should be up. A leveraged ETF attempts to produce returns that are a multiple of those produced by the index it is tracking. Therefore, if this index falls by 2%, the 2× leveraged fund should move twice as much (4%). With the index dropping by 2%, this inverse fund will rise by 4%; that is, $1 on a $25 index. LO 7.h

An unmanaged portfolio is a characteristic of A) a closed-end investment company. B) an open-end investment company. C) a unit investment trust. D) a single state municipal bond fund.

C) a unit investment trust. Explanation The most significant distinguishing characteristic of a UIT compared with other investment companies is the lack of ongoing portfolio management. Once the initial portfolio is assembled, it remains fixed until the termination date. Closed-end and open-end companies are classified as management companies because of the ongoing portfolio management responsibilities. Unless something indicates otherwise, when the exam refers to a fund, it is a mutual fund (open-end investment company). LO 7.a

Capital gains distributed by a mutual fund to shareholders are reported and taxable for the year A) the shares are redeemed by the fund. B) paid by the fund. C) earned (accrued). D) the shareholder chooses but not later than two years after all shares are redeemed.

C) earned (accrued). Explanation Capital gains can be distributed to shareholders by a mutual fund no more than once per year and are reported and taxable for the year earned (accrued). LO 7.f

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) an interval fund. B) a closed-end investment company. C) an open-end investment company. D) a unit investment trust.

A) an interval fund. Explanation 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. LO 7.b

A new client, age 25, earning $41,000 annually has saved $20,000 to allocate to an investment portfolio for the first time. The client says that while he would like to see some growth, an investment with moderate risk and some downside protection are important objectives for his first time investing. Aligning with the client's investment experience and objectives, which of the following would be the most suitable? A) Municipal bond fund B) Balanced fund C) Equities index fund D) Money market fund

B) Balanced fund Explanation A balanced fund, which consists of both equities and debt instruments, not only aligns with the growth objective but also offers some downside protection against falls in market due to the debt portion of its portfolio. Equity index funds move with the markets and offer no downside protection. A money market fund would not align with growth, and a municipal bond fund would have no benefit for an investor in a lower income bracket. LO 7.g

Investment clubs: I) can take advantage of breakpoints on mutual fund purchases. II) cannot take advantage of breakpoints on mutual fund purchases. III) are permitted to purchase new equity issues at the public offering price (POP). IV) are not permitted to purchase new equity issues at the POP. A) II and IV B) II and III C) I and III D) I and IV

B) II and III Explanation Investment clubs are not considered restricted persons under the rules regarding sales of a new issue, and therefore, are eligible to purchase new equity issues. Note that if a registered representative (a restricted person) were a member of an investment club, the club would be prohibited from buying a new equity issue. Investment clubs are never permitted to take advantage of breakpoints available on mutual fund purchases. LO 7.d

When calculating net investment income, an investment company includes A) only dividends. B) dividends plus interest minus operating expenses. C) only interest. D) just dividends plus interest.

B) dividends plus interest minus operating expenses. Explanation Net investment income equals gross investment income minus operating expenses. Gross investment income is interest and dividends received from securities in the investment company's portfolio. LO 7.f

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 minimum sales charge the fund distributor collects. C) the maximum sales charge the fund distributor collects. D) the average sales charge for the preceding three months.

C) the maximum sales charge the fund distributor collects. Explanation The public offering price for a quoted mutual fund includes the maximum sales charge the fund distributor can assess. LO 7.c

When an investor in a mutual fund elects to reinvest dividends into additional shares, the price paid is A) the public offering price (POP) plus a sales charge. B) the public offering price POP) without a sales charge. C) the net asset value per share (NAV). D) the net asset value per share (NAV) plus a sales charge.

C) the net asset value per share (NAV). Explanation For test purposes, all reinvestments of mutual fund dividends (and capital gains distributions) are at the NAV with no sales charge. LO 7.e

In the purchase of Class A shares, many mutual funds provide quantity discounts to those reaching breakpoints specified in the fund's prospectus. To qualify for the quantity discount, purchases of which of the following may not be combined under the definition of any person? A) A parent's account and the parent's child in a UTMA account B) A trustee of an irrevocable trust and the beneficiary of that trust C) Spouses investing in a joint account and individual accounts D) A parent and a 35-year-old child investing in separate accounts

D) A parent and a 35-year-old child investing in separate accounts Explanation For the purpose of qualifying for breakpoints, the definition of any person includes family units, but only minor children are included. Adults, other than spouses, are separate persons. Purchases made by trustees or other fiduciaries may be combined with purchases in the accounts of the beneficiary of the fiduciary account. LO 7.d

Your customer tells you she is very bearish on the market and thinks she can capitalize on that view by purchasing an inverse exchange-traded fund (ETF) that tracks the Dow Jones Industrial Average (DJIA). In a subsequent discussion, she explains her understanding of how the fund works and makes several comments that are all accurate except one. Which is the inaccurate statement that as her registered representative you would want to correct? A) It's like any other fund regarding potential losses in that I can't possibly lose more than I invest. C) The fund is managed to perform opposite of the DJIA. Because I'm bearish on the market owning, these fund shares align with my view. D) If the DJIA decreases by 10%, this ETF is managed to increase by twice that amount.

D) If the DJIA decreases by 10%, this ETF is managed to increase by twice that amount. Explanation An inverse ETF is managed to perform opposite of the index it is tracking. It is not managed to perform at any stated multiple of that performance as would be the case if it were a leveraged (2x or 3x) ETF. If the market falls, the inverse ETF is managed in such a way as to attempt to rise by the same percentage. In other words, it will perform the opposite. The invested amount is the most one can lose. Like all other exchange-traded products, shares can be sold intraday in the open market. LO 7.h

Your mutual fund has sent you a Form 1099, listing some long-term capital gains on which you must pay taxes. You are concerned that the 1099 is in error because you have owned your shares for only four months. Which of the following statements is true? A) The gain need not be reported because you have instructed the company to reinvest your dividends and capital gains, thus deferring your tax liability. B) The 1099 is incorrect because you have held your shares for less than one year, which indicates a short-term gain. C) The gain need not be reported because you have not redeemed your shares, and therefore, have not realized any gain. D) The 1099 is correct because in this case, the holding period to be considered is that of the investment company, not yours.

D) The 1099 is correct because in this case, the holding period to be considered is that of the investment company, not yours. Explanation The investment company designated the gains as long term because the company held the securities for more than a year before selling them. The holding period on your shares is relevant only if you redeem your shares for a gain. LO 7.f

Reduced sales charges are allowed under all of the following circumstances except A) a lump-sum purchase that qualifies for a breakpoint. B) additional purchases that qualify for breakpoints under rights of accumulation. C) combining separate purchases made by a client and her business partner in their respective IRA accounts. D) the customer signing a letter of intent.

C) combining separate purchases made by a client and her business partner in their respective IRA accounts. Explanation Two unrelated adults may not combine transactions to receive a breakpoint. LO 7.d

If a registered representative is comparing two mutual funds for a customer, which of the following comparisons would not be permissible? A) Comparing two equity funds with slightly different investment objectives, even if the differences and their consequences are carefully explained B) Comparing diversified growth funds from two different fund families C) Comparing a long-term bond fund to a shorter-term bond fund to demonstrate the trade-offs that exist between risk and return. D) Comparing an equity growth fund to a money market fund, with the intention of convincing an investor to purchase the growth fund

D) Comparing an equity growth fund to a money market fund, with the intention of convincing an investor to purchase the growth fund Explanation A characteristic of money market funds is that they deliberately avoid growth. Thus, for the growth investor, comparing a money market fund to a growth fund is unfair. LO 7.g

As a registered representative, you recommend the purchase of the ABC Fund family corporate bond mutual fund to a customer whose objective is current income. The customer agrees to the purchase and you enter the order. What type of securities has the investor purchased? A) Common stock B) Preferred stock C) Government bonds D) Corporate bonds

A) Common stock Explanation The customer has purchased common stock in the mutual fund because that is the only security an open-end management investment company (mutual fund) can issue. Using the customer's invested funds, the fund manager purchases securities for the fund portfolio that will meet the fund's investment objectives. For a corporate bond fund, the principal purchases for the portfolio would be corporate bonds. Likewise, if the fund were the ABC Preferred Stock Fund, the investment manager would purchase preferred stocks. Please do not confuse how a mutual fund raises capital for the manager to invest (it issues common stock shares in the fund) with what the manager invests in with that money. LO 7.b

A prospectus must be delivered to customers in the sale of all of the following transactions except A) new issues of registered common stock. B) unit investment trusts. C) exchange-traded funds (ETFs) trading in the secondary market. D) mutual funds.

C) exchange-traded funds (ETFs) trading in the secondary market. Explanation ETFs trading in the secondary market, like other securities that are already trading in the secondary market, do not require the delivery of a prospectus. LO 7.h

An attractive investment for a customer with a very high risk tolerance might be a leveraged ETF. One your firm recommends is the QUID 3× leveraged ETF. You decide to track its performance for several days during a period of high market volatility. The starting date value is $50 per share. Day one ends with the specified index down 3%. Day two sees the index rise by 4%. On the third and final day, the index declines by 1%. The value of the QUID share is now A) $50.06. B) $49.43. C) $50.00. D) $49.94.

B) $49.43. Explanation The 3× leverage will multiply the index movement by a factor of three. Should you receive a question like this, use the provided calculator as follows: $50 x 91% (3% drop × 3 = 9%) × 112% (4% up × 3 = 12%) × 97% (1% drop × 3 = 3%) and that rounds to $49.43. LO 7.h

Growth of capital is most likely to be the investment objective of which of the following mutual funds? A) A U.S. government securities fund B) A money market fund C) An asset allocation fund D) A GNMA fund

C) An asset allocation fund Explanation An asset allocation fund allocates the assets in its portfolio among equity, fixed income, and cash. The allocations change in tune with market opportunities. The equities in the portfolio are designed to generate capital growth, and proper timing of fixed income securities can also lead to growth of capital. Although the cash won't grow, moving assets into cash at the right time can reduce the amount of decline in the portfolio. The other choices all focus on income and perhaps stability. LO 7.g

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) an open-end investment company. B) a closed-end investment company. C) an interval fund. D) a unit investment trust.

C) an interval fund. Explanation 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. LO 7.b

Gerry Logan has been managing his own securities portfolio for the past 15 years. His returns have been about the same as the S&P 500, and as he gets older, he does not want to have to spend the time and effort to keep up the performance. Logan is currently 55 years old and has sufficient discretionary income and savings that enable him to take moderate risks. He is of the belief that his own experience proves that you can't beat the market. Which of the following would you suggest for him? A) 50% into an S&P 500 index fund (or ETF), 50% into an investment-grade bond fund B) 100% into an S&P 500 index fund (or ETF) C) 50% into an S&P 500 index fund (or ETF), 50% into a money market mutual fund D) 50% into an S&P 500 index fund (or ETF), 30% into an international index fund, and 20% into an investment-grade bond fund

D) 50% into an S&P 500 index fund (or ETF), 30% into an international index fund, and 20% into an investment-grade bond fund Explanation Index funds (or ETFs) are appropriate investment vehicles for investors who believe that active management does not produce returns above the cost. Investing in the S&P 500 would give him returns comparable to what he has enjoyed in the past. However, in recognition of his advancing age, it would appear prudent to diversify by placing some of the money into the international sphere and a portion into the safety of high-grade debt securities. LO 7.g

An aggressive investor is willing to risk $25,000 to align with his bearish outlook on the overall market. He notes liquidity being important if he needs to divest quickly, and risk taken needs to be commensurate with the upside potential. Which of the following would align most suitably with these objectives? A) Broad-based market inverse index fund B) Shorting broad-based index calls C) Narrow-based index fund D) Hedge fund

A) Broad-based market inverse index fund Explanation Inverse (or reverse) funds attempt to deliver returns that are opposite those returned by the index they are tracking. If the index falls, aligning with this investor's bearish market outlook, a broad-based inverse index fund should do well, generating positive returns as the index performs negatively. When shorting calls, gains are limited to the premiums collected, and losses are potentially unlimited, which is too much risk with not enough gain. Hedge funds are not deemed to be liquid and can be eliminated based on the investor's desire to get out quickly. An index fund (not inverse or reverse) moves with the market, and losses would occur if the markets faltered as this investor expects. LO 7.h

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) Business development companies B) Private equity funds C) Venture capital funds D) Hedge funds

A) Business development companies Explanation 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. LO 7.b

The price of which of the following securities is determined based on supply and demand? A) Closed-end management investment companies B) Open-end management investment companies C) Unit investment trusts D) Interval funds

A) Closed-end management investment companies Explanation It is the closed-end investment company whose price is based on supply and demand in the marketplace. There is no secondary market for any of the other choices. The buying and redeeming of open-end shares and UIT units is based on NAV. Interval funds repurchase or allow redemption of shares at certain specified intervals and those are at NAV. LO 7.c

Which of the following is the least suitable mutual fund transaction? A) Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence B) Encouraging an investor in a high tax bracket with an income objective to invest in a municipal bond fund C) Encouraging an investor in his early 30s to invest in an emerging markets mutual fund D) Encouraging a retired 65-year-old investor to invest a small percentage of his savings in a large-cap growth fund

A) Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence Explanation Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence is not in the client's best interest, as the client might be subject to substantial additional sales charges. LO 7.g

One of your customers had a sideline business that was just sold for $100,000. The customer is 47 years old and wants to put that money into an investment that can be left alone for the next 20 years until expected retirement. Which of the following is likely the most suitable choice for this customer? A) An investment grade bond fund with an average duration of 20 years B) A target date fund with a date 20 years from today C) A small-cap growth fund with reinvestment of distributions D) A portfolio that is 70/30 equities today gradually rebalancing to 50/50 at retirement age

B) A target date fund with a date 20 years from today Explanation This is exactly what target date funds are designed for. As the investor gets closer to the target retirement age, the portfolio managers shift the concentration from equities to fixed income. Why doesn't the 70/30 shifting to 50/50 portfolio work here? Because the question states that the customer wants a hands off approach, something the target date fund does automatically. The small-cap growth fund might be too aggressive, and a bond fund is not aggressive enough when the time horizon is 20 years. LO 7.g

Most exchange-traded funds (ETFs) are structured as open-end investment companies. However, they should not be confused with mutual funds. Among the differences between the two is that ETFs A) track indexes. B) compute their NAV hourly. C) are traded in the secondary markets. D) can issued preferred stock.

C) are traded in the secondary markets. Explanation The ET in ETF stands for exchange-traded. That is a solid hint that these trade on the exchanges. Stock exchanges are secondary markets. Because mutual funds are always part of a continuous new issue, their sale takes place in the primary market. Redemptions are back through the fund, not on any securities marketplace. There are mutual funds that track indexes just as ETFs do. Both compute their NAV as of the 4:00 pm close of the markets. No open-end investment company can issue preferred stock. LO 7.h

An individual participates in the 401(k) plan offered by the employer. Every two weeks, 4% of the employee's salary is deferred into the plan. The contributions are made into several different mutual funds. This practice is using A) time-weighted returns. B) constant dollar investing. C) dollar cost averaging. D) dollar-weighted returns.

C) dollar cost averaging. Explanation Investing the same amount on a regular basis is the definition of the formula-based system of dollar cost averaging. In a fluctuating market, this will always provide the lowest average cost per share. Time-weighted and dollar-weighted are ways to measure the return on the investment. A constant dollar plan is one where the amount invested remains constant, but the allocation among equity, fixed income, and cash is adjusted to reflect a specified percentage. Although dollar cost averaging is covered in your material, the other terms are not. If any of them appear as a correct answer, we will note that in the content updates on your dashboard. LO 7.e

Recent years have shown an enormous growth in the sales of exchange-traded funds (ETFs). Some of the benefits of using ETFs in your clients' portfolio would include A) greater diversification than most comparable mutual funds. B) lower risk than most comparable mutual funds. C) greater tax efficiency than most comparable mutual funds. D) greater management flexibility than most comparable mutual funds.

C) greater tax efficiency than most comparable mutual funds. Explanation In general, largely because of the lack of need to rebalance the portfolio to meet investor redemption requests or market changes, ETFs have fewer taxable events. That translates into fewer taxes to their shareholders. Because an ETF is generally restricted to those securities in the index it tracks, there will be the same diversification as a mutual fund tracking that same index. Because the mutual fund is not necessarily tied to an index, the greater management flexibility can offer greater diversification. The risk is based on the portfolio, not the structure of the company. LO 7.i

Proceeds from the sale of securities in a customer's account are usually kept in the account unless the customer requests a payment. Those funds are swept into a money market mutual fund or an interest-bearing bank deposit account. One of the advantages of having cash swept into the bank deposit account rather than the money market mutual fund is that A) the bank deposit account offers a higher yield. B) the bank deposit account is insured by the SIPC. C) the bank deposit account is insured by the FDIC. D) the bank deposit account offers a check-writing feature.

C) the bank deposit account is insured by the FDIC. Explanation One question that seems to appear on the exam regularly deals with knowing that money market mutual funds are not protected by FDIC insurance. That protection is only available to banking accounts. SIPC insures broker-dealers. The difference in yields varies with neither option constantly offering higher rates. Money market funds usually have check-writing provisions, and some broker-dealer bank deposit accounts do as well. LO 7.g