Series 65 Unit 2 Investment Company Securities

The dollar amount of purchase at which sales charges are reduced in the purchase of open-end investment company shares is known as the A) breakpoint. B) load point. C) leverage point. D) basis point.

Answer: A Large purchases of investment company shares receive reduced sales charges at given minimums of investment. These are known as breakpoints.

According to the Investment Company Act of 1940, an open-end investment company must compute its NAV: A) no less frequently than once per day. B) weekly. C) monthly. D) annually.

Answer: A Mutual funds must calculate the value of fund shares at least once per business day; funds may calculate the value more often and will disclose this fact in the prospectus.

Which of the following could NOT be an open-end fund? A) RST Fund ask price 45.25-NAV 44.80. B) WXY Fund ask price 10.50-NAV 11.25. C) LMN Fund ask price 7.75-NAV 7.50. D) PQR Fund ask price 17-NAV 17.

Answer: B Although closed-end fund shares may have an ask price below NAV, this is not true of an open-end fund. The ask price (POP) of an open-end fund is either the NAV (a no-load fund) or the NAV plus a sales charge.

A letter of intent for a mutual fund purchase may be backdated to include previous investments in the same fund during the past: A) 10 business days. B) 30 calendar days. C) 90 calendar days. D) 5 business days.

Answer: C Letters of intent may be backdated up to 90 calendar days, provided the total investment period used to qualify for the breakpoint does not exceed 13 months.

A mutual fund's expense ratio is found by dividing its expenses by its: A) public offering price. B) income. C) dividends. D) average annual net assets.

Answer: D A mutual fund's expense ratio is calculated by dividing its expenses by its average annual net assets.

If an investor wants to invest in the electronics industry but does not want to limit his investments to only one or two companies, which type of fund would be most suitable? A) Bond. B) Money market. C) Hedge. D) Specialized.

Answer: D A specialized or sector fund invests 25% or more of its assets in a particular region or industry.

A client invests $2,200 in an open-end investment company and signs a letter of intent for a $10,000 breakpoint. If he deposits $11,000 6 months later, which of the following statements is TRUE? A) He will receive a reduced load on $10,000 worth of the shares. B) He will receive a reduced load on $8,800 worth of the shares. C) He will not receive any reduction in the sales load. D) He will receive a reduced load on $13,200 worth of the shares.

Answer: D An investor signing a letter of intent has 13 months to contribute funds to reach the reduced load. The sales charge in this case, then, will be based on the total investment of $13,200. If at the end of the 13 months the investor had not invested up to the breakpoint, the fund would liquidate enough shares to pay the difference in sales load.

All of the following may receive breakpoint discounts EXCEPT: A) a pension plan trustee. B) an investor in an individual retirement account. C) a husband and wife in a joint account. D) an investment club.

Answer: D Breakpoints are not available to investment clubs.

Which of the following is NOT an investment objective that must be stated in an investment company's prospectus? A) Tax-advantaged income. B) Retirement. C) Growth. D) Income.

Answer: B Retirement savings and income are objectives of an investor, not of an investment company fund. Growth, income, and tax-advantaged income are investment company objectives.

A customer who seeks to supplement his retirement income and has a high risk tolerance would find which of the following securities most suitable? A) Municipal GOs. B) Investment-grade bond funds. C) High-yield bond funds. D) Treasury receipts.

Answer: C High-yield bonds yield more than investment-grade bonds. Since the client has a high risk tolerance, these bonds are more appropriate than investment-grade bonds that yield less.

Open- and closed-end investment companies have all of the following in common EXCEPT that they: A) actively manage their portfolios. B) have stated investment objectives. C) trade their shares in the secondary market. D) compute their net asset values.

Answer: C Open-end companies do not trade shares in the secondary market. However, both open-end and closed-end companies compute their net asset values, actively manage their portfolios, and have stated investment objectives.

If a customer's portfolio is heavily invested in common stock mutual funds, what is the customer's greatest risk? A) Changes in interest rates. B) Loss of diversification. C) Loss of liquidity. D) Loss of principal.

Answer: D A mutual fund with a portfolio of common stock is subject to market risk. If the market falls, the value of the fund's shares also fall, subjecting the owner to loss of principal.

From the standpoint of diversification, which of the following would be considered the most conservative? A) An income fund. B) A growth fund. C) A sector fund. D) A balanced fund.

Answer: D Balanced funds invest in a variety of investment vehicles; therefore, they have more diversification. Because of the diversification, they are better protected against downturns in the financial markets and are more conservative than the other choices listed.

If an investor has $20,000 to invest, but requires $500 per month to pay for her mother's nursing home care, which of the following funds should you recommend? A) Aggressive growth. B) Biotechnology. C) Foreign stock. D) Money market.

Answer: D The client's monthly income requirements suggest that the money market fund, the most liquid and safest of the investments, is the most appropriate.

Which of the following types of mutual funds would be most likely to have capital appreciation as its stated objective? A) Specialized. B) Income. C) Municipal bond. D) Balanced.

Answer: A A specialized fund invests at least 25% of its assets in one particular industry or region. Generally, its main objective is capital or price appreciation. Income funds are looking for income, municipal bond funds for tax-free income, and balanced funds for capital preservation.

Pricing of a closed-end fund is determined by: A) supply and demand for the shares. B) net asset value. C) net asset value plus a commission. D) net asset value plus a sales charge.

Answer: A Shares of closed-end funds are traded in the secondary market where prices are determined by supply and demand. The NAV of a closed-end fund is computed and not determined by the market price or trading price. Closed-end funds do not have sales charges but do have commission charges added to the market price.

The price of listed closed-end investment company shares is determined by A) the board of directors B) the net asset value plus the sales charge C) supply and demand D) the exchange on which the shares trade

Answer: C Closed-end investment company shares trade in the secondary market. Therefore, like other listed securities, supply and demand determine price.

Which of the following may be done only with the approval of the shareholders of an investment company? A change from diversified to nondiversified status. The purchase of particular bonds on the open market. Personnel changes in the transfer agent's organization. A change in the fund's objectives. A) I and III. B) II and III. C) II and IV. D) I and IV.

Answer: D Any substantive change in an investment company's form, structure, investment objective, or business operation must be approved by a majority vote of the outstanding shares. Bond purchases are left to the fund's portfolio manager, and the transfer agent is trusted with its organization's personnel changes.

Which of the following is likely to be characterized by no management fees and a portfolio consisting of municipal or corporate bonds? A) Face amount certificate companies. B) Closed-end investment companies. C) Open-end investment companies. D) Unit investment trusts.

Answer: D Only management companies, (open and closed end) have management fees.

A sector fund is one where the assets are: A) invested in emerging growth companies. B) invested in special situations. C) invested in other mutual funds. D) concentrated in a particular industry or geographical area.

Answer: D Sector funds (specialized funds) target at least 25% of their investments toward a specific industry or geographical location.

A customer wishes to invest $97,000 in the XYZ Growth Fund, which offers only Class A shares. If the fund has a breakpoint sales charge discount at the $100,000 investment level, the course of action least appropriate for an agent is to: A) simply place the order as instructed. B) inform the customer that he might be able to reduce his sales charge through rights of accumulation if he owns shares of this fund through another broker/dealer. C) inform the customer that he can reduce his sales charge by investing another $3,000. D) inform the customer that he can reduce his sales charge through a letter of intent.

Answer: A If a customer places an order for an amount just below a breakpoint threshold, he should be informed of the breakpoint discount as well as the various methods by which he can achieve it.

Which of the following investments is the most liquid? A) Variable annuities. B) Common stock. C) Money market funds. D) Foreign stock funds.

Answer: C Money market funds are the most liquid investment.

A customer invests $18,000 in a mutual fund and signs a letter of intent for $25,000 to qualify for a breakpoint. One year later, the shares are valued at $25,100 even though the customer has made no new investments. Which of the following statements is TRUE? A) Shares held in escrow will be liquidated at the appreciated value. B) The letter of intent is considered fulfilled. C) The agent should remind the customer of the letter of intent that was signed 12 months ago. D) The investment no longer qualifies for a breakpoint.

Answer: C The letter of intent is not satisfied by the price appreciation of the shares. A letter of intent must be met with dollars invested within 13 months, so the customer needs to invest an additional $7,000 to fulfill the letter of intent. The agent should remind the customer of the intention to qualify for the reduced sales charge. The provisions of the LOI hold regardless of the price appreciation. Shares will not be liquidated until 13 months have lapsed.

Which of the following statements correctly describes a mutual fund or open-ended investment company? A) In contrast to a closed-end investment company, a mutual fund will eliminate systematic risk. B) Marketability is limited as a willing buyer must be found in the secondary marketplace. C) Shareholders are not taxed on the earnings of the fund since taxation takes place at the entity level. D) Each investor's account value is based on the number of shares owned multiplied by the fund's net asset value.

Answer: D An investor's account value in a mutual fund is based on the number of shares multiplied by the fund's net asset value. As long as the fund distributes a certain percentage of its income, there is no taxation at the entity level; rather, shareholders pay tax on the distributions. Guaranteed marketability of fund shares is ensured.

If an investor is looking for an open-end investment company with an objective of providing current income to its shareholders, she would most likely choose: A) a venture capital fund. B) a growth fund. C) a hedge fund. D) an income fund.

Answer: D Income funds provide the highest current income of the choices offered. The other choices would generally not hold many income-producing securities in their portfolios.

The tax consequence of transferring proceeds from one fund to another within the same family of funds is: A) on the date of the transaction, any gain or loss is recognized for tax purposes. B) no gain or loss is recognized until redemption. C) gains are taxed and losses are deferred. D) losses are deducted and gains are deferred.

Answer: A An exchange is the sale and then a purchase of a new security and is therefore a taxable event.

Ms. Foster is retiring in two years and will need income. Which of the following mutual fund types would most likely be the least desirable for her? A) A special situation fund. B) A balanced fund. C) A growth and income fund. D) A bond fund.

Answer: A Special situation mutual funds are risky and would not usually be considered suitable for a potential retiree.

To calculate the amount to be received on redemption of open-end investment company shares, which of the following would be used? A) The NAV, minus the redemption fee. B) The NAV, plus the redemption fee. C) The offering price, plus the redemption fee. D) The offering price, minus the redemption fee.

Answer: A The mutual fund will redeem shares at the NAV. Redemption fees or deferred sales loads, if any, are subtracted from the proceeds sent to the investor.

An investment company that invests in common stock, preferred stock, and bonds would most likely be classified as a(n): A) sector fund. B) balanced fund. C) growth fund. D) income fund.

Answer: B Balanced funds spread the risk of their investments among different types of securities, such as common stock, preferred stock, and bonds. Growth funds concentrate more on growth than balance. As a result, they will have a higher concentration of common stock. Income funds will consist mostly of bonds and some preferred stock. Finally, sector funds will focus on specific industries or technologies.

Which of the following are characteristics of a money market mutual fund? Shares are offered without a sales charge. There is a redemption fee. All purchasers must receive a copy of the prospectus. The letter of intent must be signed within 16 months. A) II and IV. B) I and III. C) I and IV. D) II and III.

Answer: B Money market funds are offered without sales loads or redemption fees. As with all mutual funds, a prospectus is required.

Which of the following will most likely be the most volatile investment over a short-term time period? A) An intermediate municipal bond fund. B) A money market fund. C) A growth-oriented common stock fund. D) An intermediate corporate bond fund.

Answer: C Because stocks are more volatile than bonds, a growth-oriented stock fund will be more volatile than bond funds.

An investor who initially makes a small investment in a mutual fund may have the advantage of a lower sales charge on investments made over a 13-month period through a(n): A) redemption letter. B) investment letter. C) syndicate letter. D) letter of intent.

Answer: D An investor who signs a letter of intent stating she will invest a specified amount over a 13-month period may be eligible for breakpoints. Breakpoints entitle investors to reduced sales charges.

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

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

An investor reading the open-end investment company section of today's "The Wall Street Journal" sees that Bull in the Teashop Fund has a NAV of $10.65 and an offering price of $11.15. He knows that he would have received which of the following if his redemption order had been received by the fund prior to yesterday's market close? A) $10.65. B) $10.65, less commission. C) $10.65, less redemption fee, if any. D) $11.15, less redemption fee, if any.

Answer: C An investor redeeming his shares will receive the NAV less any redemption fee that may be described in the prospectus. Investors redeeming through the fund are not charged a commission.

Clients should be aware of the potential effects of volatility on their portfolios. Which of the following would most likely have the lowest volatility? A) A government bond fund. B) A large-cap fund. C) A money market fund. D) A balanced fund.

Answer: C Money market funds traditionally maintain a stable net asset value resulting in no market volatility.

If an investor is in a low tax bracket and wishes to invest a moderate sum to gain some protection from inflation, which of the following would you recommend? A) Municipal unit investment trust. B) Money market mutual fund. C) GNMA fund. D) Growth mutual fund.

Answer: D Growth funds invest chiefly in common stock. Historically, common stock provides greater protection from inflation than debt securities do.

The GEMCO Asset Allocation Fund is in registration. In order for the fund to charge the maximum allowable sales charge on its Class A shares, the fund's prospectus must allow which of the following? Rights of accumulation. The privilege to exchange shares of this fund with other GEMCO funds at NAV. Price breakpoints offering reduced commissions for larger purchases. A) I and III. B) I and II. C) II and III. D) I, II and III.

Answer: A Industry rules prohibit sales charges in excess of 8-½% on mutual fund purchases. However, in order to do so, shareholders must be given rights of accumulation and breakpoints must be available for larger purchases (generally starting at $10,000 or $15,000). There is no requirement to offer the exchange privilege.

Your married customers, ages 48 and 50, have a combined annual income of more than $200,000. They are concerned about the effects of rising inflation, and since they are heavily invested in bonds, they seek to invest a portion of their portfolio in a fund that will provide additional diversification. Which of the following mutual funds is the most suitable for these customers? A) ATF Overseas Opportunities Fund. B) NavCo Tax-Free Municipal Bond Fund. C) ABC Investment-Grade Bond Fund. D) XYZ Government Income Fund.

Answer: A Investment in an overseas equity fund will provide diversification not necessarily subject to U.S. inflation. The tax-free fund will not provide additional diversification or the best hedge against inflation. A high-grade bond fund will not add diversification.

The main purpose of dividend reinvestment in a mutual fund accumulation plan is to: A) compound the growth of a mutual fund investment. B) avoid taxes. C) protect against capital loss. D) avoid commissions or sales charges.

Answer: A Reinvesting dividends compounds the growth of the fund with periodic purchases of new shares. Taxes are due on dividends whether or not they are reinvested. Capital gains or losses will occur whether or not dividends are reinvested. The purchase of additional shares with reinvested dividends may increase the capital gain or loss in proportion to the dividends reinvested. Avoiding commissions or sales charges is not the main rationale for reinvesting dividends, even though sales charges are not applied to reinvested dividends.

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) A growth fund. C) An index fund. D) An income fund.

Answer: B 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.

The primary difference between an open-end and a closed-end investment company is: A) regulation. B) management. C) capitalization. D) diversification.

Answer: C An open-end investment company continuously offers for sale and stands ready to redeem a constantly changing number of shares; therefore, its capitalization is constantly changing. On the other hand, a closed-end investment company issues a fixed number of shares and does not redeem its own shares. Therefore, its capitalization is fixed.

As defined in the Investment Company Act, investment companies include: A) open-end companies, closed-end companies, and unit investment trusts. B) diversified companies, nondiversified companies, and face-amount certificate companies. C) face-amount certificate companies, management companies, and unit investment trusts. D) mutual funds, closed-end companies, and unit investment trusts.

Answer: C The act defines investment companies as being management companies, face-amount certificate companies, or unit investment trusts. Management companies are further categorized as being open-end or closed-end, diversified or nondiversified.

In the context of purchasing shares in a mutual fund, the term "breakpoint" refers to the point at which: A) the investor is assured of making a profit on the shares. B) the shares are selling for less than net asset value (NAV). C) the dollar amount of shares being purchased qualifies the investor for a lower sales charge. D) the mutual fund company stops offering new shares to the public

Answer: C The term "breakpoint" refers to the point at which the number of shares being purchased is large enough to qualify the investor for a reduced sales load. FINRA prohibits broker/dealers and their agents from making a mutual fund sale at just below the breakpoint merely to obtain a larger commission.

Which of the following statements regarding a mutual fund that offers class A, B, and C shares are TRUE? Class A shares have a front end sales charge and a low 12b-1 fee. Class B shares have a declining contingent deferred sales charge and a high 12b-1 fee. Class C shares have a high 12b-1 fee and a level contingent deferred sales charge. Class B and C shares allow investors to put the shares back to the fund for their original purchase price for up to 1 year after purchase. A) I and II. B) I, II, III and IV. C) I, II and III. D) I only.

Answer: C There is no put provision that guarantees the return of an investor's purchase price associated with mutual fund shares.

All of the following are characteristics typical of a money market fund EXCEPT: A) the underlying portfolio consists of short-term debt instruments. B) it is offered as a no-load investment. C) its net asset value normally remains unchanged. D) it has a high beta and is safest in periods of low market volatility.

Answer: D A money market fund has almost no price volatility, since the underlying portfolio consists of low-beta instruments, and the fund is deliberately managed for low beta.

Under the 1940 Investment Company Act, an investment company may take all of the following forms EXCEPT a(n): A) open-end investment company. B) closed-end investment company. C) unit investment trust. D) limited partnership with partners as passive investors.

Answer: D An investment company is not a limited partnership. Investment companies are organized as open-end companies (mutual funds), closed-end companies, unit investment trusts, or face-amount certificate companies.

If general interest rates increase, the interest income of a bond unit investment trust will probably: A) change as soon as the portfolio manager can take advantage of the higher rates now available in the marketplace. B) decrease. C) increase. D) remain the same.

Answer: D Since the portfolio of a UIT is fixed, the income generated by that portfolio will not change. Remember, a UIT does not have a portfolio manager.

Your firm's market analyst believes the current bullish market in equities will continue. Which of the following would be most suitable for a growth-oriented investor? A) Preferred stock. B) Large-cap stock. C) Bond. D) GNMA.

Answer: B A large-cap stock would be a reasonable investment for a growth-oriented investor in a bullish economic environment. Bonds are not a growth-oriented investment vehicle, GNMAs provide monthly income (not the growth that the client seeks), and preferred stocks are appropriate for income-oriented investors.

If general interest rates increase, the interest income of an open-end bond fund whose sales exceed redemptions will likely: A) remain unchanged. B) It cannot be determined from the information given. C) increase. D) decrease.

Answer: C Most mutual funds do not have 100% of their assets in securities, and they continually receive new money from investors. Any increase in the general interest rate would allow the fund to purchase new, higher-yielding instruments, which would increase the fund's income.

A mutual fund must redeem its tendered shares within how many days after receiving a written request for their redemption? A) 5 days. B) 10 days. C) 7 days. D) 3 days.

Answer: C The 7-day redemption rule is required by the Investment Company Act of 1940.

Who safeguards the securities held in a mutual fund's portfolio? A) The trustee. B) The corporation. C) The custodian. D) The manager.

Answer: C The Investment Company Act of 1940 requires that investment companies employ the services of a commercial bank as custodian to hold and safeguard the physical assets (cash and investment portfolio) of the fund.

Charles wishes to preserve his capital and generate income with moderate risk by investing in mutual funds. Which of the following mutual fund types would probably least meet these investment objectives? A) A bond fund. B) Technology funds. C) A balanced fund. D) An income fund.

Answer: B Technology mutual funds typically invest in high-risk, high-reward situations that are inappropriate for conservative investors. Balanced funds, income funds, and bond funds could be potential investments for conservative clients.

A client buys 100 shares of a mutual fund on December 28, 2011, for $4,000 and receives a capital gains distribution of $2.40 per share on March 6, 2012, which is taken in cash. He sells his 100 shares for $4,300 on June 19, 2012. For tax purposes, this transaction will result in a: A) $60 short-term capital gain. B) $240 long-term capital gain. C) $240 long-term capital gain and a $60 short-term capital gain. D) $300 short-term capital gain.

Answer: D The June sale of the shares purchased in December results in a short-term capital gain of $300. The distribution represents a long-term gain of $240, but this question only deals with the client's transaction.

A review of the prospectus of an open-end investment company reveals that its portfolio consists entirely of CDs, Treasury bills, and repurchase agreements. This is probably a(n): A) money market fund. B) balance fund. C) exchange-traded fund (ETF). D) index fund.

Answer: A Money market funds hold money market instruments like negotiable CDs, Treasury bills, banker's acceptances, commercial paper and repurchase agreements.

You have a client who originally invested $25,000 into the ABC Growth Fund. Over the past 5 years, there have been no distributions and the value of the shares is now $35,000. If the client should ask about exchanging the entire holding for shares of the ABC Income Fund, you would explain A) there is a long-term capital gain of $10,000 B) that taking advantage of the exchange privilege results in taxes being deferred until the liquidation of the account C) the new shares would be acquired at the public offering price D) the new shares will have the same cost basis as the old ones

Answer: A The exchange privilege permits shares of one fund in the family (The ABC Fund group) to be exchanged for shares of another at net asset value, not public offering price. However, for tax purposes, it is considered a sale and a purchase so there would be a capital gain realized on any difference between the cost basis and the proceeds. In this case, the new shares would have a new cost basis of $35,000.

Which of the following is NOT an advantage of investing in a mutual fund? A) Professional portfolio management. B) Absence of market and business risk. C) Portfolio diversification. D) Identifiable investment objectives.

Answer: B Mutual funds offer investors the benefits of portfolio diversification, identifiable investment objectives, and professional portfolio management. They do not completely do away with market and business risk, however. Even if a mutual fund invests in a diversified portfolio of stocks, a poorly performing market can reduce the fund's returns. In addition, portfolio managers for mutual funds can sometimes perform poorly and fail to generate acceptable returns.

Which of the following types of investment company securities is the most likely to have a NAV that is 90% of its offer price? A) Face-amount certificate. B) Closed-end company share. C) Open-end company share. D) Unit investment trust unit.

Answer: B The market determines the offer price of closed-end company shares; the offer price may be either more or less than the NAV. Because the NAV in this situation is 90% of the offer price, this must be a closed-end share. An open-end share's NAV must be at least 91.5% of its offered price because the maximum sales charge on open-end shares is 8.5% of the POP.

An investor signed a letter of intent to purchase $50,000 worth of Sky-High Mutual Fund. At the end of 13 months, he had only invested $48,000 in the fund. Which of the following is TRUE? A) He has 90 days to invest the additional $2,000 for the breakpoint. B) He must sign a new letter for the $2,000 to receive the breakpoint. C) The fund will liquidate shares to meet the additional sales charge. D) There are no additional requirements; he will receive the breakpoint.

Answer: C An investor has only 13 months to meet a letter of intent commitment. Once that period of time has elapsed, the investment company is entitled to a refund of the discount it had originally given the investor. This is accomplished by liquidating a sufficient number of shares to cover the additional sales charge to be imposed.

An open-end investment company is also referred to as a(n): A) face amount certificate company. B) exchange traded fund. C) mutual fund. D) unit investment trust.

Answer: C Investment companies may be one of three types: unit investment trusts, face amount certificates, or management companies. Within the category of management companies, you will find open- and closed-end companies. Open-end investment companies are also referred to as mutual funds.

The exchange privilege offered by open-end investment companies allows investors to: A) exchange personally owned securities for shares of the investment company. B) purchase new fund shares from dividends. C) delay the payment of taxes on shares. D) exchange shares of one open-end fund for another in the same fund family at a net asset value basis.

Answer: D Exchange privileges allow an investor to convert the value of shares held in one fund for those of an equal value in the same family. Remember that conversion is a taxable event; if the shares converted have increased in value, capital gains taxes will be due.

Your married customers are both 42 years old, have 2 children ages 14 and 12, and they have spent the last 10 years accumulating money to provide for their children's education. Their oldest child will enter college in 4 years, and the customers are very cautious investors. If they need a safe investment that provides regular income to help them meet tuition payments, which of the following mutual funds is the most suitable for these customers? A) ABC Stock Index Fund. B) ATF Overseas Opportunities Fund. C) RST Balanced Fund. D) LMN Investment-Grade Bond Fund.

Answer: D These clients cannot afford a downturn in the stock market between now and the time they want to send their children to college. An investment-grade bond fund will provide the income and safety required for accumulating additional funds for college expenses.

Disregarding any potential redemption or CDSC fees, an investor tendering shares of an open-end investment company for redemption will receive the: A) next computed public offering price. B) next computed net asset value plus a portion of the sales load. C) last computed net asset value. D) next computed net asset value.

Answer: D When an investor redeems (or purchases) open-end investment company shares, the investor receives the next computed net asset value (NAV) of those shares. This is known as the forward pricing rule.

Which of the following statements about closed-end investment companies are TRUE? Investors in closed-end investment companies may trade only in full shares. Shares in closed-end investment companies may trade at more or less than the net asset value of the shares. A closed-end investment company offers a fixed number of shares and does not continually offer new shares in response to investor demand. A) I, II and III. B) I and II. C) I and III. D) II and III.

Answer: A A closed-end investment company makes an initial public offering of stock, and once those shares have been purchased no more shares are available from the company until it offers a new issue. Investors may purchase shares of a closed-end investment company on an exchange or over the counter at whatever price the market demands. This price may be more or less than net asset value. Investors may not buy or sell fractional shares but may trade only in full shares.

A new customer has a $35,000 CD maturing in 2 weeks. With the objective of maximizing his income on capital invested, he wishes to invest the proceeds in a mutual fund. Which of the following types of funds should be recommended? A) A venture capital fund. B) An income fund. C) A growth fund. D) A sector fund.

Answer: B An income fund is just what the name implies; it invests for income (regular payments of interest and/or dividends).

Which of the following statements regarding letters of intent used in connection with mutual fund purchases are TRUE? The letter can cover a period totaling 16 months. The letter may be backdated 90 days. Some shares purchased are held in escrow until the letter is completed. During the period covered by the letter, the customer may not redeem his shares. A) III and IV. B) II and III. C) I and II. D) I and IV.

Answer: B Letters of intent permit investors to qualify for a reduced sales charge on the purchase of mutual fund shares over time. They are valid for 13 months and may be backdated by up to 90 days to include prior purchases. The investor is not legally obligated to comply with the terms of the letter, so some shares purchased at the reduced sales charge are held in escrow. These shares are liquidated to repay the reduction in sales charge if the contract is not completed.

The XYZ Mutual Fund reports that a large number of their investors have been liquidating shares. In fact, the dollar amount of liquidations exceeds the incoming cash for new purchases. This would lead to a condition known as: A) reduced sales charges. B) net redemptions. C) cash outflow. D) negative performance.

Answer: B One of the main features of open-end investment management companies (mutual funds) is that there is a continuous offer of new shares and ready redemption of old ones. When redemptions exceed new purchases, the fund suffers from net redemptions.

Open-end investment companies must do all of the following EXCEPT A) publish their management fees B) meet the 75-5-10 diversification test C) issue shares with voting privileges D) redeem their shares on request

Answer: B ​Open-end investment companies, (mutual funds),​ may be classified as diversified or non-diversified depending on their stated objectives. ​It is only those which are diversified that must comply with the 75-5-10 rule. ​However, mutual funds must issue shares with voting privileges, redeem their shares on request, and publish their management fees.

Which of the following statements regarding a closed-end investment company is TRUE? A) The number of outstanding shares is constantly changing. B) The shares are redeemable. C) The shares are sold at a current market price. D) New shares are constantly offered to the public.

Answer: C A closed-end company issues a limited number of shares in a single offering to be sold by the underwriter at a set public offering price. Once the shares are sold, they trade on an exchange or OTC, where supply and demand in the market sets the trading price.

Potential investment company clients should be advised to investigate a fund by looking at which of the following? Investment policy. Number of shares outstanding. Custodian bank. Portfolio. A) II and III. B) II and IV. C) I and IV. D) I and III.

Answer: C Investment policy, track record, portfolio, and sales load should all be researched when assessing a fund. The identity of the custodian bank for the fund, or number of shares outstanding, does not bear on its performance or suitability.

The Investment Company Act of 1940 states that: A) an investment company must have $5 million capital before its securities can be offered to the public. B) no more than 50% of the board of directors of an investment company may be officers or employees of the company or investment advisers to the company. C) open-end companies may issue common stock only. D) it is unnecessary for the prospectus to disclose the management fee.

Answer: C Open-end companies may issue only common stock. The prospectus must state the management fee, and an investment company needs only $100,000 to offer itself to the public. In addition, no more than 60% of the board of directors can be made up of officers or employees of the company.

A 45-year-old investor wants the greatest possible monthly income with the preservation and stability of capital as secondary objectives. Which of the following investments would you recommend? A) Growth mutual fund B) Growth and income fund C) Long-term bond fund D) Money market mutual fund

Answer: C The only choice that provides stability of capital is the money market fund, but that is not one of the investor's objectives and the monthly income is quite low. Although the two other funds don't offer stability, they certainly don't provide a high income (even the growth and income fund). If you want income, you invest in bonds, especially those with longer maturities.

If a securities salesperson encourages a customer to invest $20,000 in Class A shares in each of 3 different families of mutual funds, which of the following is most likely to occur? A) Improved diversification B) Reduced expense C) Private transaction violation D) Breakpoint sale violation

Answer: D Class A shares means there is a front-end load. Those selling the funds must inform the customer that there are breakpoints at which the customer could save money from reduced sales charges.However, those breakpoints are only available when investing in funds that are part of the same "family." It is likely that there are breakpoints at $25,000 and/or $50,000 that the salesperson is avoiding. Diversification among different management groups is acceptable, but one must be careful not to prevent the client from taking advantage of breakpoints or quantity discounts within a family of funds. It is likely that the salesperson's recommendations are resulting in increased expense, not less. Private securities transactions occur away from a broker-dealer.

Which of the following is NOT a standard used to determine whether a particular mutual fund is suitable for an individual investor? A) Components of an investor's current portfolio. B) The amount of time elapsing between the deposit of the investment and the investor's anticipated use of the funds. C) The investor's estimated tolerance for risk and volatility. D) Whether the investment is made directly through the fund itself or through a broker/dealer.

Answer: D Whether a mutual fund is offered through the issuer or through broker/dealer channels is not a suitability determinant. However, time horizon, risk tolerance, and existing portfolio components help determine investment suitability.

Your 30-year-old client has $100,000 to invest and she is willing to assume a moderate amount of risk, but would also like to have $10,000 available for a down payment on a home in 6 months. Which of the following asset allocation strategies would best suit her situation? A) 50% government bond fund, 50% large-cap fund. B) 70% large-cap stock fund, 20% balanced fund, 10% money market fund. C) 50% large-cap stock fund, 40% municipal bond fund, 10% money market fund. D) 70% high-yield corporate bond fund, 20% growth fund, 10% government bond fund.

Answer: B A high concentration (70%) in large-cap securities for growth and inflation protection is the most appropriate asset allocation for the client profile. The client also has 10% in a money market fund for liquidity purposes (down payment of a house) and the rest in a balanced fund.

A couple in their early 30s has been married for 4 years, their disposable income is relatively high, and they are planning to buy a condominium. If they need a safe place to invest their down payment for about 6 months, which of the following mutual funds is the most suitable for these customers? A) XYZ Investment-Grade Bond Fund. B) LMN Cash Reserves Money Market Fund. C) ATF Capital Appreciation Fund. D) ABC Growth & Income Fund.

Answer: B These customers are preparing to make a major purchase within the next few months, so they require a highly liquid investment to keep their money safe for a short amount of time. The money market fund best matches this objective.

Last year, the bond market was profitable and ABC fund had 70% of its assets in bonds. Next year, the fund's managers expect the equity market to outperform and will adjust the fund's portfolio so that 60% of its assets will be invested in stock. ABC is most likely: A) a Growth fund. B) an Income fund. C) a Specialized fund. D) an Asset allocation fund.

Answer: D A mutual fund whose portfolio managers have the flexibility to allocate between different investment classes is known as an asset allocation fund.

Which of the following statements about the redemption of mutual fund shares are TRUE? A mutual fund may, but is not required to, redeem its shares if requested by a shareholder. A mutual fund will redeem fractional shares as well as full shares. Redemptions of mutual fund shares are handled under forward pricing. A) I and III. B) I, II and III. C) II and III. D) I and II.

Answer: C A mutual fund is required by law to redeem (buy back) its shares on the request of a shareholder, and a mutual fund will redeem fractional shares as well as full shares. Redemptions are handled under what is known as forward pricing, which means that the redemption price will be the next net asset value per share calculated after the mutual fund receives the request for redemption.

Your client is 75 years old and has $100,000 to invest. He enjoys a relatively high income and is not concerned with immediate liquidity, although he is risk averse. The most suitable asset allocation strategies listed below would be a: A) 50% municipal bond fund, 50% large-cap common stock fund. B) 50% municipal bond fund, 40% money market fund, 10% large-cap common stock fund. C) 50% municipal bond fund, 40% government bond fund, 10% large-cap common stock fund. D) 50% municipal bond fund, 40% government bond fund, 10% money market fund.

Answer: C The allocation of 50% municipal bond fund, 40% government bond fund, and 10% large-cap common stock is appropriate for a high-income person age 75 who is not concerned with liquidity. The 10% large-cap fund provides some inflation protection with very moderate downside risk.

If a customer purchases shares in a municipal bond fund, which of the following statements are TRUE? Dividends are taxable. Dividends are not taxable. Capital gains distributions are taxable. Capital gains distributions are not taxable. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D Dividends distributed by municipal bond funds are federal tax free (and in some cases, state tax free as well) in alignment with the tax rules of how the fund's investment income was earned. However, any capital gains distribution resulting from the sale of bonds held long term by the fund is subject to taxation to the shareholder.

When an agent explains mutual funds to a prospective investor, which of the following statements may be made? A) The redemption value of mutual fund shares fluctuates according to the fund's portfolio value. B) Mutual fund shares are liquid and may be switched from fund to fund without tax liability. C) A fund always redeems shares at NAV, with little chance of a financial loss. D) Mutual funds must make payment within seven days of a redemption request and guarantee a return of the original investment.

Answer: A Mutual fund redemption values fluctuate according to the value of the securities in the portfolio. The tax liabilities associated with mutual fund switching may not be glossed over. While the redemption rules of the Investment Company Act of 1940 do make mutual funds liquid, investors are not guaranteed to receive an amount equal to the original investment.

Which of the following statements about open-end investment companies are TRUE? Open-end investment companies are also known as mutual funds. Open-end investment companies continually offer shares for sale to the public. The price at which an open-end investment company will sell shares to the public is based on the share's net asset value (NAV). A) I and III. B) II and III. C) I, II and III. D) I and II.

Answer: C An open-end investment company is also known as a mutual fund. One of the distinguishing characteristics of open-end companies is their continuous offering of new shares. The price at which open-end investment companies sell shares to the public is always NAV plus any sales charge or load indicated in the prospectus.

One of the most important definitions found in the Investment Company Act of 1940 is that of "investment company". Included in that definition are all of the following EXCEPT: A) face-amount certificate companies. B) unit investment trusts. C) management investment companies. D) REITs.

Answer: D Even though REITs (real estate investment trusts) share many of the same characteristics of investment companies, they are not included in the definition as found in the Investment Company Act of 1940.

The fee charged by some mutual fund companies if shares are redeemed within a specified time after being purchased is known as a: A) contingent deferred sales charge. B) forward pricing fee. C) breakpoint fee. D) 12b-1 fee.

Answer: A Some mutual funds impose contingent deferred sales charges on investors who redeem their shares within a specified period after purchasing them. These fees are designed to encourage investors to leave their money in the fund for longer periods. Typically, the amount of the contingent deferred sales charge decreases the longer the investor owns the shares.

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

Answer: B In all of 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 portfolio offers 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.

Which of the following investments is the most liquid? A) Oil drilling limited partnership interest B) Common stock in a small oil drilling corporation that is quoted on the OTC Link C) Long-term municipal bond fund D) Municipal revenue bond issued by a township

Answer: C The long-term municipal bond fund is the most liquid because it is a mutual fund (a redeemable security), and the investor is assured of a buyer that will exchange money for the redeemed fund shares within seven days of the redemption request. Municipal bonds of a township, especially those that are from extremely small issuers, may have thin trading markets where sellers have difficulty finding willing buyers. There is not an active secondary market for reselling interests in limited partnerships. Stock of a small corporation that trades on the OTC Link (formerly known as the "Pink Sheets") may also have a thin trading market.

Net asset value per share for a mutual fund can be expected to decrease if the: A) fund has made dividend distributions to shareholders. B) securities in the portfolio have appreciated in value. C) issuers of securities in the portfolio have made dividend distributions. D) fund has experienced net redemptions of shares.

Answer: A If dividends are distributed to shareholders, the fund's assets will decrease and value per share will fall accordingly. Appreciation of the portfolio and dividends paid to the portfolio will increase the value. If issuers have made distributions to the portfolio, the net asset value will increase. Net redemptions have no effect on the net asset value, as the money paid out is offset by a reduced number of shares outstanding.

Which of the following is NOT a restriction that the SEC has placed upon money market mutual funds? A) No more than five percent of the funds assets may be invested in below-investment grade securities. B) Investments are limited to securities with remaining maturities of 397 days or less, with the average portfolio maturity not to exceed 90 days. C) Investments are limited to eligible securities determined to have minimal risk. D) The prospectus must prominently indicate that the U.S. government does not guarantee the fund and that there is no guarantee that the NAV will be maintained.

Answer: A The SEC requires that money market mutual funds' investments be limited to securities that are rated in the top-2 ratings categories by the nationally recognized rating services (e.g., Moody's, Standard & Poor's). Investment in below-investment grade securities is not allowed.

A prospect has primary investment objectives of current income and safety of principal. During the initial public offering of a closed-end government bond fund, an agent explains to the prospect that the fund invests in U.S. government-backed bonds, which are very safe as to principal, and plans to make monthly distributions. Little could therefore go wrong. Taken as a whole, this representation is: A) accurate because the fund invests in government bonds. B) accurate because the fund offers current income. C) misleading because government bonds experience considerable credit risk. D) misleading because closed-end fund shares are subject to market pricing.

Answer: D Though parts of the agent's presentation are factually accurate, overall, the statements are misleading, because the value of the fund is subject to unpredictable change. Closed-end funds can, and often do, trade below their net asset value, thus subjecting the customer's principal to risk.

Investing in which of the following would maximize after-tax income and diversify the portfolio for a high tax bracket investor? A) Tax-exempt unit investment trusts B) GNMAs C) Short-term municipal notes D) Preferred stock mutual fund

Answer: A The key word here is "diversify". Tax-exempt unit investment trusts will own a number of different tax-exempt municipal issues. Short-term municipal notes, although paying tax-free interest, will not offer as high a return due to the short maturities and do not indicate that there is diversification as to issuers.

A mutual fund has a net asset value (NAV) of $7.80 per share, and the fund pays its underwriter a concession of $0.12 per share. If the fund has a sales load of $0.50 per share and an administrative fee of $0.15 per share, how much does the investor pay per share to purchase a Class A share of this fund? A) $8.57. B) $8.30. C) $7.80. D) $8.42.

Answer: B The investor pays the public offering price (POP) when purchasing mutual fund shares. For a Class A share upon purchase, the POP is the NAV plus the sales charge.

Which of the following activities would have an effect on the NAV of a mutual fund? The sale of securities from the portfolio. Automatic reinvestment of dividends by the shareholders. Market appreciation of portfolio securities. Market decline in the value of portfolio securities. A) I and II. B) I, III and IV. C) I, II, III and IV. D) III and IV.

Answer: D The formula to determine NAV is: assets minus liabilities divided by shares outstanding. The sale of securities from the portfolio will replace the asset (securities) with an equal value of the asset (cash) and will have no effect on the NAV. The reinvestment of dividends will also not affect the NAV, because the shares going out are offset equally by the cash coming in. Market appreciation or decline will, however, affect the NAV because asset value will either increase or decrease, but liabilities and shares outstanding will remain unchanged.

An investor has a portfolio diversified among many different asset classes. If there was an immediate need for cash, which of the following would probably be the most liquid? A) CDL Common Stock Mutual Fund. B) QRS Money Market Mutual Fund. C) Cash value from a universal life insurance policy. D) XYZ International Stock Mutual Fund.

Answer: B Money market funds generally come with a check-writing privilege offering investors the opportunity to convert the asset to cash at once. Although all mutual funds are readily redeemable, under the Investment Company Act of 1940, the fund has 7 days to redeem. One must request the cash value from the insurance company.

A retiree contacts an agent to discuss investing his retirement savings of approximately $2.1 million; his investment objective is long-term growth. The representative and customer discuss the advantages and disadvantages of diversifying among 5 different mutual funds within 2 fund families, as opposed to purchasing just 1 fund. Consequently, the agent made the following purchase recommendations: XYZ Emerging Growth Class B $495,000. XYZ Research Class B $310,000. XYZ Investors Growth Stock Class B $495,000. ABC Capital Enterprise Class B $495,000. ABC Capital Opportunity Class b $310,000. Total $2,105,000. These recommendations are: A) unsuitable because Class A shares in either (or both) fund family could be purchased for a sales charge breakpoint discount at or near zero percent. B) suitable because they achieve the diversification the customer seeks. C) unsuitable because the investments are not equal in amount. D) suitable because the customer fully understands all of the ramifications and is satisfied.

Answer: A Class A shares, in most mutual funds, provide breakpoint sales charge discounts so there is no sales charge when purchasing $1 million worth of shares (or less in some cases). Class A shares also have lower operating expenses than Class B shares. This retired investor would be subject to back-end loads with Class B shares if the funds were needed unexpectedly within a few years.

All of the following are advantages of mutual fund investment EXCEPT: A) the investor retains personal control of her investment in the fund portfolio. B) exchange privileges within a family of funds managed by the same management company. C) the ability to invest almost any amount at any time. D) the ability to qualify for reduced sales loads based on accumulation of investment within the fund.

Answer: A The control of the investment is given over to the investment manager. Exchange privileges, the ability to invest any amount at any time, and reduced sales loads are all considered advantages.

Which of the following statements regarding investment companies is NOT true? A) When an open-end investment company, or mutual fund, registers its offering with the SEC, it does not specify the exact number of shares it intends to issue. B) An investment company can offer investors two ways of participating in the fund under management through the purchase of closed-end shares or, if the investor prefers, open-end redeemable shares. C) The Investment Company Act of 1940 classifies investment companies into three types: face-amount certificate companies, unit investment trusts, and management investment companies. D) When investors sell or redeem their open-end fund shares, they receive the net asset value (NAV) as of the close of the day the order was issued.

Answer: B An investment company cannot offer investors two ways of participating in the fund under management. The fund must either be a closed-end fund with shares traded in the marketplace or an open-end fund with redeemable shares. The Investment Company Act of 1940 classifies investment companies into three types: FACs, UITs, and management investment companies.

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) decline the transaction because short-term trading of funds is not allowed. B) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee. C) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee. D) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee.

Answer: B 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. But, you ask, we don't know what the CDSC is for the Class B shares - it isn't given. It doesn't have to be because the CDSC for redemptions in the first year would never be lower than the Class A front-end load (4% in this question and certainly higher than the 1% on the Class C shares).

Your customer, age 60, is retired and living at home with a fully paid-off mortgage. Her portfolio contains growth stocks and high-quality bonds, and she is a long-time investor and comfortable with moderate risk. Her objective is a moderate level of current income to supplement her corporate pension plan distributions and the earnings from her IRA. Which of the following mutual funds is the most suitable for this customer? A) QRS Capital Appreciation Fund. B) XYZ Biotechnology Fund. C) ABC Equity Income Fund. D) LMN Stock Index Fund.

Answer: C An equity fund that aims to achieve both current income and growth of income best suits the objectives and investment profile of the client. A stock index fund does not offer the current income that the client requires. The capital appreciation and biotechnology funds not only fail to provide income; they are too risky for this retired person.

A customer with no other mutual fund investments wishes to invest $47,000 in the XYZ Technology Fund. If the Class A shares are eligible for a breakpoint sales charge discount at the $50,000 investment level, the action least appropriate for an agent is to: A) inform the customer that he can reduce his sales charge through a letter of intent. B) inform the customer that he can reduce his sales charge by combining purchases in other funds offered by XYZ group. C) place the order as instructed. D) inform the customer that he can reduce his sales charge by investing an additional $3,000.

Answer: C If a customer intends to invest an amount just below a breakpoint threshold, he should be informed of the breakpoint discount, as well as the various methods by which he can receive it.

An agent has recommended investments in the XYZ fund family to his customers for 10 years. He is referred by one of his customers to a prospect who has inherited $500,000 as beneficiary of a life insurance policy. The prospect tells the agent she has never invested in the market before, is risk averse, and wants safety of principal to be the first priority with liquidity second. The agent recommends the following investments: XYZ government bond fund, B shares $200,000. XYZ large-cap growth and Income B shares $150,000. liquid reserve money market $150,000. The recommendation is: A) suitable because he recommended conservative investments. B) suitable because it addresses the customer's safety objective. C) suitable because it addresses the customer's liquidity objective. D) unsuitable because it does not address the customer's two primary objectives

Answer: D The customer's objectives of safety and liquidity are not satisfied by these recommendations. The government bond fund and large-cap growth and income fund are both subject to market risk and, as Class B shares, are subject to a contingent-deferred sales charge in the event the customer wishes to access the funds before the back-end load expires. The back-end load is not consistent with the customer's liquidity objective.

Shareholders of mutual funds have all of the following rights EXCEPT: A) preemptive rights. B) voting rights. C) voting proxies. D) receiving semiannual reports.

Answer: A Shareholders of mutual funds have all of the rights mentioned except a preemptive right-the right of existing shareholders to maintain a proportionate ownership in the fund. The sale of shares of an open-end investment company (mutual fund) is a continuous primary offering.

Many sophisticated investors have added alternative investments to their portfolios. Benefits in doing so would include: A) portfolio diversification. B) greater regulation than traditional investments such as stocks and bonds. C) returns that generally exceed those of traditional stock and bond investments. D) lower expenses than traditional stock and bond investments.

Answer: A Alternative investments, such as limited partnership vehicles and hedge funds, have a tendency to add diversification to a traditional stock and bond portfolio. Many alternative investments have little or no regulation and their expenses are typically high.

When an open-end management investment company computes its net asset value per share, each of the following occurrences would have an impact EXCEPT A) a greater value of shares being redeemed than purchased B) interest payments made on debt securities held in the fund's portfolio C) a drop in the value of equity securities held in the fund's portfolio D) a capital gains distribution

Answer: A Because shares are purchased and redeemed at NAV, net redemptions (this case) or net purchases have no effect on the net asset value of the fund's shares. However, receipt of cash in the form of interest payments causes assets to increase while falling equity prices leads to a decrease. Distributions of capital gains (or dividends), represents a payment of cash, thus decreasing the amount of assets on hand.

Which of the following types of investments would have the lowest liquidity risk? A) Real estate. B) Money-market funds. C) Preferred stock. D) Gold.

Answer: B Money market funds offer check-writing privileges permitting their investors to cash out virtually immediately.

When shares of a closed-end investment company are purchased by an investor, the price paid is based upon the: A) current asking price. B) net asset value. C) net asset value plus commission. D) current bid price.

Answer: A Closed-end investment company shares are priced based on supply and demand. The ask is the price that investors will pay for purchasing shares and the bid is what investors receive when selling. Investors will also pay a commission as this is what the broker charges for executing the transaction. Shares of open-end investment companies are bought and redeemed based on NAV, but that is not so of closed-end companies.

Which of the following securities would most likely have the lowest expense ratio? A) Exchange-traded fund. B) Balanced mutual fund. C) Variable annuity. D) Hedge fund.

Answer: A Generally, most ETFs have a lower expense ratio than do comparable mutual funds. ETFs have other advantages over mutual funds in that they can be bought or sold at any time during the trading day (as opposed to end of day pricing), they can be bought on margin, and they can be sold short. Variable annuity expense ratios tend to be higher than mutual funds and those for hedge funds are the highest of all.

The prospectus for a fund states that the minimum initial investment is $500,000. This is most likely what type of fund? A) Hedge. B) Balanced. C) Small-cap growth. D) Specialized.

Answer: A Hedge funds, due to their much higher risk, usually limit their investors to those who can afford to take that higher risk by having very high minimums.

Which of the following statements concerning hedge funds are TRUE? Purchasers of hedge funds are generally required to be accredited investors. Short sales by the fund are not allowed. It is not uncommon for there to be a lock-up period that may last for as long one year or even longer. It would be unusual for the fund managers to have an ownership interest in the fund. A) I and III B) I and IV C) II and III D) II and IV

Answer: A Purchasers of hedge funds are usually required to be accredited investors. Hedge funds often have high liquidity risk due to the lock-up provision which can restrict an investor's ability to liquidate the position. An advantage of hedge funds is their ability to sell securities short during bear markets, adopt risky arbitrage strategies, and otherwise take direct steps to maximize returns in both up and down markets. In almost all cases, the fund managers have a significant ownership position in the fund, or as the phrase goes, they have "skin in the game."

Why are "country" funds organized as closed-end funds? A) Because it is often difficult to liquidate the foreign securities to get their value into the U.S. B) The United Nations Investment Act of 1952 requires that they all be closed-end C) Because redemption at net asset value within 7 days is assured D) So that additional capital may easily be raised

Answer: A There are a number of funds that invest exclusively (or predominately) in the shares of companies domiciled (and traded) in a single country. Not all securities markets are as liquid as those in the U.S. and many countries have currency restrictions limiting the amount of money that may be taken out of the country at any one time. Therefore, organizing as a mutual fund is not very practical. With no need to redeem shares, closed-end companies are the obvious solution. Please Note. In recent years, things have changed and today, a majority of country funds are now open-end companies (mutual funds). We are urging NASAA to remove or revise any questions that deal with "old" information and will update our questions (and LEM) when they do.

One of your clients has seen the value of the aggressive growth fund in her portfolio fall by over 70%. Which one of these actions might be appropriate for her IAR? A) switch to a more conservative fund in the same fund family. B) switch to a money market fund in the same fund family. C) stay in this fund hoping for a recovery. D) take advantage of the drop in value by purchasing additional shares at this lower price.

Answer: A This question calls for a subjective answer and one could actually argue on behalf of any of these. But, for purposes of the exam, it would be most appropriate to suggest to the client that the sale would generate a tax loss and that perhaps moving into a less aggressive fund would enable the client to recover some of the loss of value. Obviously, the switch should remain in the same fund family to take advantage of the NAV to NAV transfer, avoiding a new sales charge.

Your elderly client has $10,000 to invest and seeks preservation of capital and a moderate income stream. If she has never invested in mutual funds before and all of her savings are in bank CDs and saving accounts, you should recommend a: A) government bond fund. B) money market fund. C) T-bill. D) tax-exempt bond fund.

Answer: B A money market fund is the most appropriate for an elderly person seeking preservation of capital and some income on a regular basis. A T-bill, although safe, provides interest income only at maturity. Because the client has never invested in mutual funds before, she may be uncomfortable with the potential fluctuations in principal of the bond funds. This exam will not want you to go so far as to claim, "but if the client purchased 4 week T-bills, there would be the ultimate safety and income every 28 days". No client with this background is going to be trading every month - don't go there.

Investment company portfolio managers are apt to classify common stocks into groups. One measurement is the product of multiplying the market price per share times the number of shares outstanding. The result is known as: A) debt to equity ratio. B) market capitalization. C) market value. D) total value.

Answer: B A stock's market capitalization is determined by multiplying the price per share times the number of outstanding common shares. For example, if a company had 1 billion shares outstanding and the market price was $20 per share, the company would be said to have a market cap of $20 billion. This would put it into the category of "large-cap" stocks.

One of your clients wishes to invest in a fund of hedge funds. You could tell him which of the following? A) Shares of these funds are easy to redeem. B) Expenses for these funds tend to be higher than those for other funds. C) He can expect to make a profit whether the markets trend up or trend down. D) These funds purchase a large amount of preferred stock.

Answer: B Funds of hedge funds purchase interests in a variety of hedge funds, which typically use risky strategies to generate profit regardless of market direction. Redemption may be difficult with these funds, and the steps management must take to try to generate profits incur higher expenses than traditional mutual funds.

If you were describing an investment that trades on an exchange with a price set by supply and demand, rather than its underlying value, it would be a (an): A) forward contract. B) closed-end fund. C) hedge fund. D) open-end fund.

Answer: B The stock of closed-end investment management companies trades on exchanges and, like any other exchange security, is priced based upon supply and demand. Although closed-end funds compute their NAV, it is market forces that determine price.

Which of the following would be the most important reason for an investor interested in adding foreign stocks to his portfolio to do so by purchasing an international mutual fund? A) He could select a fund whose portfolio had the proper mix of foreign and domestic stocks to maximize his diversification. B) He would have the benefit of the portfolio managers picking the stocks instead of having to rely on his own efforts. C) Purchasing foreign stocks through a mutual fund saves on foreign taxation. D) The voting rights granted to a mutual fund shareholder are much stronger than those to the holder of an ADR.

Answer: B There are two primary benefits to purchasing any mutual fund: professional management and diversification. However, an international fund has NO domestic securities in the portfolio (that would be a global fund) so there would be no mix for diversification as indicated in that choice. There are no special tax breaks for investing in foreign securities via a mutual fund and the voting rights have nothing to do with the securities in the portfolio.

When comparing exchange-traded funds (ETFs) to mutual funds, some features available in ETFs that are NOT found in the mutual funds would include the ability to: correlate to a specific index. sell short. be bought and sold on margin. represent an entire portfolio, or basket of securities. A) III and IV. B) II and III. C) I and II. D) I and IV.

Answer: B Unlike mutual fund shares, ETF shares can be traded on margin and sold short. They are similar in that they both represent an entire portfolio or basket of securities and both can have portfolios correlated to a specific index.

Why would you suggest a client invest in foreign mutual funds? Diversification. Tax benefits. Avoids having to pick individual stocks. Greater regulatory controls. A) II and III. B) I, II, III and IV. C) I and III. D) I and IV.

Answer: C A foreign mutual fund invests in the securities of companies that are not domiciled in the U.S. Therefore, we have the benefit of added diversification. A mutual fund offers us the specific benefit (whether foreign or domestic), of not having to worry about individual stock selection - the professional managers do that. There are no specific tax benefits to investing through the fund rather than directly and, in most cases, the regulatory controls in other countries do not offer the same degree of investor protection as those of the U.S.

Hedge funds are issued by A) Administrators B) investment companies C) limited partnerships D) portfolio advisers

Answer: C Almost all hedge funds are issued as limited partnerships with the investment adviser (portfolio manager) having an investment in the fund.

A hedge fund and a traditional mutual fund are similar in that: A) both typically have low initial investment requirements. B) both use long and short positions, swaps, and arbitrage. C) their portfolio managers are likely to effectuate trades on a daily basis. D) both offer performance incentives to the fund manager.

Answer: C Both traditional mutual funds (as opposed to index funds) and hedge funds are actively traded. This means that the portfolio managers are buying and/or selling securities on a daily basis. Hedge funds always offer performance incentives; it is much less common among mutual funds. Hedge funds have very high initial purchase levels and can engage in speculative trading strategies.

A customer is interested in an exchange-traded fund (ETF). With regard to the trading of ETFs, the customer should be aware that: ETFs can be purchased throughout the trading day. ETFs use forward pricing, as all mutual funds do. real-time quotes are available for ETFs. the NAV calculated at the end of the day, plus a sales charge, will equal the trading price. A) II and III. B) II and IV. C) I and III. D) I and IV.

Answer: C ETFs can be traded throughout the trading day. Changing price quotes are available in real time as investors buy and sell. Although ETFs have an NAV that is calculated on the basis of the portfolio holdings, the trading price is determined by supply and demand in the open market, with customers paying commissions.

All of the following are characteristics of exchange-traded funds EXCEPT A) they are typically designed to track an index B) they generally have a lower expense ratio than comparable mutual funds C) they are redeemable securities D) they are priced by supply and demand continuously during the trading day

Answer: C Exchange-traded funds have many similarities to closed-end investment companies. They are traded based on supply and demand rather than redeemed and are typically designed to track a particular index, such as the S&P 500. In most cases, ETFs have lower operating expense ratios than mutual funds with similar objectives.

A 50-year-old client with modest means wants to construct an investment program. He has no investment experience, his major consideration is saving for retirement, and he has limited risk tolerance. Which of the following would you recommend? A) Aggressive growth mutual funds. B) Call options on the S&P 500 Index. C) Growth and income mutual funds. D) High-grade bond fund.

Answer: C Mutual funds that offer growth and income best meet the client's needs, offering growth for retirement and current income. A high-grade bond fund would not offer the growth that the client needs for retirement, although the fund would supplement the modest income of the client. A client of modest means may not be able to sustain the risk of principal that accompanies an aggressive growth fund; in addition, this alternative is unsuitable because the client has limited risk tolerance. Index options are a speculative investment.

If your clients, spouses both age 50, are interested in long-term growth and are willing to accept a moderate amount of risk, you should recommend a(n): A) money market fund. B) equity/income fund. C) municipal bond fund. D) large-cap stock fund.

Answer: D Large-cap common stock has relatively moderate risk with likely growth potential.

A client of yours has been investigating a particular mutual fund. She mentions that she saw a blurb on the Internet that the fund has had net redemptions over the past 6 months and asks you to explain how that might affect the fund's performance. You should explain that this is a good thing because now, with less money to invest, the fund's adviser is able to be more selective performance will probably suffer because the fund's adviser will have to sell positions prematurely in order to meet redemption requests this would be a good time to buy because the supply of shares exceeds the demand many of the fund's expenses are relatively fixed so with less assets in the fund, the expense ratio will probably increase A) I and IV B) I and III C) II and IV D) II and III

Answer: C When a fund has net redemptions, it means that less money is coming in than is going out. In order to meet those redemptions, the fund's manager will either have to sell securities that they planned to hold on to, or maintain more assets in cash (which generally will return less than other investments). Because the expense ratio is the annual expenses divided by the average annual assets, with less assets to cover the fixed expenses, the ratio will probably increase.

You have a client who wishes to invest $100 per month into something that will give him the opportunity to share in the long-term growth prospects of the overall economy. Which of the following would probably be the most cost efficient investment vehicle? A) A fund of hedge funds. B) An exchange traded fund (ETF) that mimics the S&P 500. C) Class A shares of a large-cap growth fund. D) A no-load index mutual fund that mimics the S&P 500.

Answer: D Although there is possible room to argue, we'll go with what the exam would choose. The only other logical choice is the ETF, but, since each purchase involves a commission and, on $100 purchases investors don't get any real break, most experts agree that ETFs are not suitable for dollar cost averaging plans (unless the periodic investments were substantial).

Which of the following statements best describes a hedge fund? A) A closed-end investment company employing leverage through the use of debt and preferred stock financing B) An investment company, registered under the Investment Company Act of 1940, that charges higher than usual management fees and employs sophisticated investment techniques in an attempt to provide level returns during periods of market uncertainty C) An investment pool, generally unregistered, that, through the use of sophisticated market tools, offers investors returns that generally exceed those available elsewhere D) A private and unregistered investment pool that accepts investor's money and employs sophisticated hedging and arbitrage techniques using long and short positions, leverage and derivatives, and investments in many markets

Answer: D As of the date of this course, hedge funds are not registered with the SEC (their managers generally are) and are invariably sold in private offerings, usually under Regulation D of the Securities Act of 1933. Hedging and arbitrage techniques using long and short positions, leverage and derivatives, and investments in many markets are some of the primary techniques used by these funds.

Which of the following statements correctly describe similarities between exchange-traded funds and closed-end investment companies? There are a limited number of outstanding shares. They are traded on registered stock exchanges. They trade at prices that are not dependent upon but close to their net asset value. Investors pay commissions to purchase and liquidate their positions. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D Both exchange-traded funds and closed-end investment companies are traded on exchanges; therefore, investors pay a commission when purchasing and liquidating shares. Only closed-end investment companies have a limited number of shares. Closed-end funds may trade at significant premiums or discounts from their NAV, while ETFs rarely stray far from NAV.

Under adverse market conditions, it is not unusual for mutual fund investors who had been investing on a regular basis to cease or reduce their level of financial commitment. This can have the effect of: A) reducing the NAV of the fund as the demand for new shares wanes. B) reducing the operating expense ratio of the fund. C) a reduction in the fund's net operating income due to a reduction in sales charges received. D) net redemptions.

Answer: D In adverse market conditions, not only do some investors stop putting money in, they liquidate their holdings. If new sales fall while liquidations rise, the effect could be net redemptions. The NAV is not affected by supply and demand and, if anything, the expense ratio would rise because some of the expenses would remain the same, but would be shared by fewer assets. Mutual funds do not receive the sales charges - they go to the underwriter.

Under the Investment Company Act of 1940, which of the following are considered management companies? Open-end companies. Closed-end companies. Unit investment trusts. Face-amount certificate companies. A) I and III. B) II and IV. C) III and IV. D) I and II.

Answer: D Management companies are subclassified into open-end companies (mutual funds) and closed-end companies. Unit investment trusts are a type of investment company that is not managed, as are face-amount certificate companies.

When reading the prospectus for a fund, you notice that it states that the fund may make portfolio purchases on margin, take short positions, and use arbitrage techniques. This is most likely what type of fund? A) Closed end. B) Exchange traded. C) Index. D) Hedge.

Answer: D Margin trading and selling short are techniques commonly found in hedge funds, rather than in open-end or closed-end management funds or ETFs.

An investor is in a low tax bracket and wishes to invest a moderate sum in an investment that will provide some protection from inflation. Which of the following should you recommend? A) Municipal unit investment trust B) Money market mutual fund C) Ginnie Mae fund D) Mid-cap common stock mutual fund

Answer: D Mid-cap stocks have historically provided good hedges against inflation making them appropriate for an investor seeking long-term growth and inflation protection. There are several key words here to remember for the exam. Whenever you see "low tax bracket," the answer cannot be a municipal bond. Likewise, whenever you see "inflation protection," the answer will be common stock (unless a TIPs is given as a choice).

By their very nature, mutual funds offer investors: A) current income. B) tax deferral. C) guaranteed returns. D) diversification.

Answer: D Mutual funds invest in a broad range of securities, giving their investors diversification.

A mutual fund would have net redemptions when A) the fund manager is selling more securities in the portfolio than are being purchased B) the fund is performing below the average of other funds with the same objectives C) the fund increases its sales charge D) the number of shares being liquidated by investors exceeds those being purchased

Answer: D One of the characteristics of an open-end investment company (mutual fund) is the ease of redeeming holdings. When the dollar amount of shares being redeemed exceeds that of those being purchased, the result is net redemptions. Although poor performance could lead to net redemptions, that is not always the case so it is not always a true statement.

One of your advisory clients meets the financial requirements for investing in a hedge fund. Having read so much about their outstanding performance, he asks you to describe any negatives to adding one to his portfolio. You could respond: A) the designed strategy of many hedge funds is to generate positive returns in both rising and falling markets. B) with a large variety of available investment styles, investors have a plethora of choices to assist them in meeting their objectives. C) as part of an asset allocation class, hedge funds may reduce overall portfolio risk and volatility and increase returns. D) Expenses tend to run very high diminishing the funds' performance.

Answer: D One of the risks in investing in hedge funds is the very high overhead, largely in the form of management fees. The other choices here are all advantages of hedge funds.

A customer has expressed interest in exchange-traded funds (ETFs) and wishes to discuss them with you. You could tell him all of the following EXCEPT: A) Selling short and trading on margin are available transactions with ETFs. B) A share of an ETF represents an entire portfolio, or a specific selection, of securities. C) Real time quotes are available for ETFs. D) ETFs have a NAV, calculated at the end of the trading day, that serves as the trading price until the next NAV is calculated.

Answer: D While a NAV can be calculated for an exchange-traded fund, the price is set by the market and changes throughout the trading day.