Series 6: Investment Companies (Holding Mutual Fund Shares)

Which of the following statements concerning a "no-load" mutual fund is correct? I The fund does not charge a front-end sales charge or a contingent deferred sales charge II The fund may sell its shares without a prospectus because shares are offered by direct mail and media advertising III The fund can charge annual 12b-1 fees to shareholders of no more than .25% of net assets IV The fund can charge annual 12b-1 fees to shareholders of no more than .75% of net assets

I and III A "no-load" fund cannot impose a front-end sales charge or a contingent deferred-sales charge on investors. However, FINRA rules permit it to charge annual 12b-1 fees of no are more than 1/4 of 1% of net assets (not 3/4% of net assets, which is the maximum permitted 12b-1 fee for "load" funds). All mutual funds must offer their shares with a prospectus, since every share is considered to be a "new issue."

Which of the following statements concerning automatic reinvestment of dividends and capital gains is correct? I Reinvestment of capital gains is a taxable transaction and reduces the investment efficiency of a mutual fund investment II Reinvestment of dividends and capital gains reduces the effect of compounding III Investors can elect to reinvest all distributions or none IV Reinvestment of dividends causes tax on the dividends to be deferred until the shares are sold

I and III Fund distributions are taxable to the investor; it makes no difference if they are reinvested or not. By reinvesting distributions, an investor buys additional shares on which additional distributions will be made, so investment returns are compounded. Typically, reinvestment of dividends is not permitted unless capital gains are also reinvested. Reinvesting dividends and capital gains does not defer income tax - the tax is due for the year the distribution was made, whether reinvested or not.

A customer that buys shares of a mutual fund on the record date is: I entitled to the dividend II not entitled to the dividend III obligated to pay tax on the dividend IV not obligated to pay tax on the dividend

I and III If a customer buys the mutual fund shares on the record date, the customer will receive the dividend and must pay income tax on the dividend received. If a customer knows that a fund is going to pay a dividend, he or she should wait until the ex-date (which is the day after the record date) or after to buy the shares to avoid this result. By purchasing the shares prior to the ex-date, the customer will get the dividend, but the customer will also have to pay tax on the dividend received. This is especially painful if the customer is automatically reinvesting dividends, since the tax bill will have to be paid with other funds. If the customer waits until the ex-date or after to buy the shares, the price per share is now reduced by the dividend that the customer will no longer receive. Thus, the customer really loses nothing except a tax bill by waiting to purchase the shares until the ex-date or after.

Termination of a 12b-1 plan requires approval by a majority of the outstanding shares or by a majority of which of the following groups?

"Non-interested" members of the Board of Directors Termination of a 12b-1 plan requires vote of the majority of either the outstanding shares or the "non-interested" members of the Board of Directors (1 level of approval).

The ex-dividend date for a mutual fund is:

1 business day following the record date The fund's board of directors sets the ex-date for a mutual fund. Fund shares do not trade, so there is no exchange such as NASDAQ that sets the ex-date. Rather, the ex-date is set by the fund board of directors. Fund shares trade only in cash transactions, and a purchase on the record date provides ownership on that date, so the buyer will receive the dividend. The ex-dividend date the following business day. Anyone who buys on the ex-date or after does not get the distribution and does not pay for it either! The fund reduces the price of its shares for the amount of any dividend or capital gains distribution on the ex-date.

To adopt a 12b-1 plan, what approvals must a mutual fund obtain?

A majority vote of shareholders, directors, and disinterested directors To adopt a 12b-1 distribution plan, a majority vote of the fund's outstanding shares is required, as well as a majority vote of the members of the board of directors and a majority vote of the non-interested (independent) members of the board. Another term for non-interested is disinterested. For the exam, know this as "3 required approvals" to adopt a 12b-1 plan. Also note that termination of a 12b-1 plan is much simpler - it only requires a majority vote of either the shareholders or the independent members of the board of directors. So only 1 approval is required to terminate the plan.

Under what condition may investors use mutual fund shares as collateral for bank loans?

After the position has been held in the customer account for 30 days Mutual fund shares may be used as collateral for a margin loan only after they have been fully paid for at least 30 days. At that point, they have a "loan value" of 50%, meaning that for every $1 of fund shares pledged as collateral for a loan, $.50 can be borrowed.

Which of the following statements concerning advantages of a mutual fund investment is correct?

Funds keep track of the purchases and sales of shares by investors so recordkeeping for taxes is easier Funds keep track of the purchases and sales of shares by investors, so recordkeeping for taxes is easier. Funds report distributions of dividends, interest (if the fund is a bond fund), and capital gains on Form 1099-DIV. Funds do not pay the taxes on distributions - it is the fund shareholder who pays the tax. Diversification has no effect on tax liability for fund shareholders.

Who sets the ex-dividend date for a mutual fund?

Fund Board of Directors Because mutual fund shares do not trade, the ex-date is not set by an exchange. Rather, the ex-date for a mutual fund is set by the Board of Directors of the fund. The ex-date for mutual fund shares is the business day following the record date - this is the date the fund actually pays out the distribution. This is the first day that an order placed to buy fund shares will no longer entitle the purchaser to the dividend.

Which of the following statements concerning the "exchange privilege" of a mutual fund family are correct? I The customer can switch among funds with different investment objectives without incurring a sales charge II When the customer switches funds, any gain in the fund from which the customer switches is deferred until sale of the new fund III Within the fund family, the customer can exchange fund shares for shares in another fund at the next computed NAV IV When a customer exchanges fund shares for money market shares, there is a redemption and reinvestment fee

I and III only The "exchange privilege" allows a customer to switch from one fund to another fund in the same family without incurring sales charges. Note that the IRS views such a transaction as a sale of one security; and with a purchase of a different security. On the sale, if there is a gain on the fund shares sold, there can be a taxable gain. The exchange privilege permits one fund to be exchanged for another in the same family with no sales charges, making Choice IV incorrect.

A management company started the year with a NAV per share of $15.64 and a POP of $17.00 per share. At the end of that year, the fund has a NAV of $14.08 per share and a POP of $15.30 per share. During the year, the fund declared and paid a dividend of $1 per share. Which of the following statements are true? I The fund is open-end II The fund is closed-end III The fund has experienced asset appreciation IV The fund has experienced asset depreciation

I and IV This fund must be an open-end management company (a mutual fund) because it is offering shares both at the beginning of the year and later on in the year at the POP (Public Offering Price). In contrast, a closed-end fund only has a POP for its initial public offering. Then the shares are listed and trade like any other stock, so there cannot be a POP for such a fund after its books have been "closed." Because NAV per share has decreased, this fund has experienced asset depreciation. The fund started with an NAV of $15.64. During the year, the fund distributed a $1 cash dividend, which would reduce NAV by $1 per share to $14.64 per share. The NAV at the end of the year is now $14.08, so NAV per share has depreciated.

A fund that calls itself a "load fund" may impose which of the following charges? I Sales charge II Contingent deferred sales charge III 12b-1 fees of 3/4 of 1% of net assets IV Management fees

I, II, III, IV A "load fund" is one that charges a sales charge, either as a front load or as a CDSC - Contingent Deferred Sales Charge. FINRA rules permit any mutual fund to charge 12b-1 fees, limited to a maximum of .75% of net assets per year. All funds charge management fees.

Which of the following expenses may be charged to shareholders under a 12b-1 plan? I Advertising II Sales literature III Underwriter's fees IV Sales loads

I, II, and III only SEC Rule 12b-1 permits a mutual to charge the cost of soliciting new investment into a fund to that fund's existing shareholders. The distribution expenses that the fund can charge to shareholders under a 12b-1 plan are: advertising; compensation of underwriters, dealers, and sales personnel; printing and mailing of prospectuses to anyone other than current shareholders; and the printing and mailing of sales literature. The fund deducts these from the net asset value once per year as an ongoing expense of soliciting new shareholders to the fund. Sales loads are an up-front deduction, taken out before money is invested into the fund. These are not part of annual 12b-1 charges.

Which of the following statements concerning automatic reinvestment of dividend distributions paid on mutual fund shares are correct? I Automatic reinvestment of distributions will result in an increase of NAV per share II Typically, investors may automatically reinvest dividends and capital gains without payment of sales charges III Typically, investors who elect to reinvest capital gains are obligated to reinvest dividends IV Typically, investors electing to reinvest dividends are not obligated to reinvest capital gains

II and III If dividends and capital gains distributions are made, they will decrease NAV per share. If these distributions are automatically reinvested, they buy proportionately more shares at the reduced NAV per share, with no change in the aggregate value of the holding. Shareholders that elect to have distributions reinvested must have both dividends and capital gains automatically reinvested.

In order for a mutual fund to materially increase its 12b-1 fees, approval is required from all of the following EXCEPT the:

Securities and Exchange Commission To materially increase its level of 12b-1 expenditures, a mutual fund must get approval of the majority of shareholders. In addition, a majority of the board of directors and the independent directors on the board must approve of the increase. This is the same rule as for adopting the plan in the first place.

Which statement regarding funds that impose the maximum 12b-1 fee is true?

Such funds charge sales and promotional fees to shareholders in addition to the sales load 12b-1 funds are permitted to charge to existing shareholders the following distribution expenses: advertising, compensation of underwriters, dealers, and sales personnel, printing and mailing of prospectuses to anyone other than current shareholders, and the printing and mailing of sales literature. The idea behind such charges is that they will attract new investments into the fund. As the fund's asset base increases, the fund will become more efficient - that is, its expense ratio will decrease. (The expense ratio is: All expenses/Total net assets.) The fund deducts 12b-1 fees from total net assets once per year as an ongoing expense of soliciting new shareholders to the fund. Sales loads are an up-front deduction, taken out before money is invested into the fund. These are not part of annual 12b-1 charges. However, funds imposing over 1/4 of 1% in 12b-1 fees are considered to be load funds because the shareholders do pay (indirectly) for soliciting costs. Management fees paid to the investment adviser for managing the fund's portfolio have no bearing on 12b-1 fees.

Which of the following statements is correct concerning 12b-1 fees for advertising and marketing of mutual fund shares?

The board of directors approves the plan annually and reviews the expenditures quarterly The board of directors approves the plan and the level of expenditures for 12b-1 fees annually. The board must review actual expenditures quarterly.

Which of the following statements concerning the payment of 12b-1 fees for promotional expenses is (are) correct?

The fees are paid from the assets of the fund The fund pays 12b-1 fees out of the assets of the fund, not from the sales load. For example, a fund may approve a 12b-1 fee of .50% of net assets annually. These fees pay for promotional expenses, so they are not paid to the fund manager, who is paid for managing the fund. They are not paid by the custodian bank; they are paid from the net assets of the fund.

Last year the ABW fund total net assets appreciated by 5%. There was no new net investment into the fund. The fund also made a 5% dividend distribution for the year. ABW had no capital gains distribution for the year and distributes 100% of its net investment income to shareholders. After payment of the dividend, how will the total assets of the fund stand in relation to the beginning of the year?

Total assets remained unchanged The asset appreciation in the fund increases total net assets by 5%. The dividend distribution of 5% will reduce net assets. Based on the information given in the question, there was no reinvestment of these dividends, since there was no new net investment. Thus these dividends went out of the fund and did not return to buy new net assets. The net effect is "0" because the asset appreciation of 5% is exactly offset by the dividend distribution of 5%.

From which of the following sources will a mutual fund compute 12b-1 fees?

Value of the fund's total net assets Mutual funds that have adopted 12b-1 plans may deduct the costs of marketing and advertising from the net assets of the fund. For example, a fund may approve a 12b-1 fee of .50% of net assets annually.

All of the following statements concerning advantages of a mutual fund investment are correct EXCEPT:

investors receive share certificates to evidence their investment Investors in mutual funds are not sent share certificates - mutual fund share certificates do not exist! All ownership records are kept electronically, and the customer gets account statements showing ownership.

In the financial media, a fund that imposes a 12b-1 fee is identified with the symbol:

p Funds that have adopted 12b-1 plans are identified in the financial media with the symbol "p" - as in "plan."

If a mutual fund declares a dividend equal to 4% of current NAV (currently at $12.00 per share), and its NAV declines by 4% on the ex-date, the shareholder who reinvests dividends can expect that his or her purchasing power will:

remain unchanged The dividend is 4%, and the NAV drops by 4%, so the reinvestment of dividends will just replace the drop in the NAV. The shareholder will own more shares having a lower per share value, but the aggregate value of the holding does not change. Note that the investor will have to pay income tax on the dividend - it makes no difference if it is reinvested or not.

If a fund offers a reinstatement privilege, all of the following statements are true EXCEPT:

shareholders may exercise the privilege once every two years shit's true: replacing withdrawn funds generally must occur within 30 days the investor may replace the withdrawn funds with no sales charge investors will find the terms of the reinstatement privilege in the fund prospectus Shareholders may exercise the reinstatement privilege only once. The investor must replace the withdrawn funds within 30 days and does not pay a sales load when replacing the funds. The fund prospectus contains the details of the reinstatement privilege.

All of the following statements concerning the sales arrangements for mutual fund shares are correct EXCEPT:

the fund may not pay marketing costs out of its assets under a 12b-1 plan of distribution shit's true: a mutual fund may sell shares directly to investors fund shares typically pass from the fund to the underwriter, to the dealer, to the investor sales charges will reduce an investor's investment in a fund A mutual fund may finance marketing and distribution costs out of fund net assets pursuant to a 12b-1 Distribution Plan. These costs are deducted as an annual percentage of net assets. Mutual funds can sell directly to shareholders without using a selling group or they can be sold via a selling group. When an order is placed, the shares go from the fund to the fund distributor (fund underwriter), then on to the selling group member (if there is one), and finally on to the customer. Any up-front sales charges will reduce the amount invested in the fund (which occurs at NAV). In addition, as shares are held, the annual 12b-1 fee will also reduce NAV.

A mutual fund notifies customers of all material facts relating to 12b-1 fees in:

the fund prospectus Disclosure of 12b-1 fees is made in the fund prospectus. If the fund shareholders approve a change in the plan, an amended prospectus must be sent to shareholders.