Series 66 - Unit 3: Pooled Investments
Which type of investment company is most often organized as a limited partnership? A. Face-amount certificate company B. Exchange-traded fund C. Hedge fund D. Unit investment trust
C. Hedge fund For various legal reasons, mostly related to the need to avoid registration with the SEC, hedge funds are generally structured as limited partnership entities, with the organizers invariably sinking their own funds into a few units.
The most common structure of a hedge fund is A. a closed-end investment management company. B. a corporation. C. an open-end investment management company. D. a partnership.
D. a partnership. For a number of reasons, mostly legal, hedge funds are most commonly structured as partnerships.
Which of the following statements regarding a unit investment trust is NOT true? A. Overall responsibility for the fund rests with the board of directors. B. It invests according to stated objectives. C. It charges no management fee. D. It is considered an investment company.
A. Overall responsibility for the fund rests with the board of directors. A unit investment trust has no board of directors; rather, it has a board of trustees. A UIT must follow a stated investment objective (as must any investment company) and does not charge a management fee because it is not a managed portfolio.
One of the characteristics of real estate investment trusts (REITs) is that they generally A. have a high degree of marketability. B. reinvest most of their income. C. offer new shares continually to investors. D. pay federal income tax on their earnings.
A. have a high degree of marketability Most real estate investments are not readily marketable. Therefore, an investor in real estate can generally expect some difficulty in converting a property to cash if cash is needed quickly. However, a REIT securitizes real estate properties, thereby allowing REIT investors to easily sell REIT shares in the open market. For purposes of the exam, all REITs are publicly traded unless something in the question indicates otherwise. REITs must flow through at least 90% of their income to investors. Therefore, the investors and not the REITs pay tax on these distributions.
Which of the following is NOT touted as an advantage to purchasing ETFs instead of index mutual funds? A. Intra-day trading B. Typically lower expense ratios C. Better general performance than the underlying index D. Can be purchased on margin
C. Better general performance than the underlying index One thing that neither of these products can claim is performance better than the underlying index. Think about it: the index has no management fees. Even though the management fees on index funds are very low and those on ETFs generally lower than that, there are still expenses making it unlikely that their performance can beat that of the index. The fact that an investor can trade the ETF during the day instead of accepting whatever the next computed price is can be a benefit for those who are trying to time the market. And for those who wish to add the leverage of margin trading (explained more fully in Unit 23), that can only be done with ETFs, not index mutual funds.
An investor is always purchasing newly issued shares of common stock when investing in A. a closed-end investment company. B. an open-end investment company (mutual fund). C. a unit investment trust (UIT). D. a holding company.
B. an open-end investment company (mutual fund). A unique characteristic of mutual funds is that they are capitalized by a continuous offering of new shares. Whenever an investor adds to her portfolio, she is buying new shares of common stock issued by that fund. In a UIT, the investor is purchasing units, not shares.
In order for a REIT to avoid being taxed like a corporation, it must distribute at least A. 75% of its taxable income. B. 90% of its taxable income. C. 95% of its taxable income. D. 100% of its taxable income.
B. 90% of its taxable income. In order to qualify under IRS regulations, REITs must distribute at least 90% of their taxable income in the form of dividends to shareholders. At least 75% of a REIT's income must come from real estate investments
Which of the following would be most likely to invest in a company based on an idea rather than actual operating results? A. An aggressive mutual fund B. A hedge fund C. A private equity fund D. A venture capital fund
D. A venture capital fund It is the venture capital fund that tends to invest in start-ups before operations have begun. That is what venture funding is all about. Private equity tends to come in a bit later, when it can offer additional funding and management expertise. With rare exceptions, mutual funds do not investment in companies that are not publicly traded. It is possible a hedge fund might take a chance on a company like this, but it would be out of the ordinary
The GEMCO Growth Fund, an open-end investment company, calculates its net asset value per share to be $9.15. Orders that were received prior to the cut-off time are executed at a public offering price of $10 per share. From this information, you know that the sales charge is A. 8.5%. B. 9.3%. C. in excess of the permitted maximum. based on the net asset value per share. D. based on the net asset value per share.
A. 8.5%. The sales charge of a mutual fund is based on the public offering price (POP), not the NAV. In this case it is the $0.85 difference between the POP and the NAV ($10 — $9.15) divided by the POP of $10. That means the sales charge is 8.5%, the maximum allowable.
An investor wants to invest $200,000 in the banking industry sector. The investor would like to utilize leverage and do this purchase in a margin account. Additionally, she stresses wanting to avoid year-end tax statements showing capital gains liabilities. You would suggest which of the following as suitable given the investor's criteria? A. A bank sector exchange-traded fund (ETF) B. A money market fund holding short-term bank notes C. Stocks in the three largest U.S. banks D. A bank sector mutual fund
A. A bank sector exchange-traded fund (ETF) The investor's criteria eliminate mutual funds as being suitable. Mutual funds typically make annual capital gains distributions, for which the owner incurs a tax liability, and mutual funds cannot be purchased on margin. Conversely, an ETF will rarely make a capital gains distribution, and because they trade like all exchange-traded products, they can be purchased on margin, making them more suitable for this investor. Buying only a few select bank stocks is not a good representation of the entire sector.
Daniella has a number of investment company products within her retirement portfolio. One of these investments trades on an exchange and may trade at a premium or discount to its net asset value. These features are most likely found in what type of investment? A. Closed-end investment company B. Unit investment trust C. Open-end investment company D. Face-amount certificate company
A. Closed-end investment company A closed-end investment company (closed-end fund, or CEF) is a type of investment company whose shares trade in the secondary market. It is critical to remember for the exam that the price of the shares of a closed-end company is based on supply and demand and, therefore, can sell at, above, or below the fund's net asset value.
The Investment Company Act of 1940 prohibits register open-end investment companies from engaging in any of the following practices EXCEPT: A. issuing common stock B. selling short or purchasing securities for the company's portfolio on margin C. owning more than 3% of the outstanding voting securities of another investment company D. opening a joint account with another investment company
A. issuing common stock The one thing that all open-end investment companies must do is issue common stock. That is the form of ownership. All of the other activities are prohibited.
A REIT can avoid being taxed as a corporation by A. receiving 75% or more of its income from real estate and distributing 90% or more of its net investment income to its investors. B. receiving 100% of its income from real estate and distributing 90% or more of its net investment income to its investors. C. receiving less than 75% of its income from real estate and distributing 100% of its net investment income to its investors. D. receiving less than 50% of its income from real estate and distributing 50% or more of its net investment income to its investors.
A. receiving 75% or more of its income from real estate and distributing 90% or more of its net investment income to its investors. Under the guidelines set by the Internal Revenue Code, a REIT can avoid being taxed as a corporation by receiving 75% or more of its income from real estate and distributing 90% or more of its net investment income to its investors.
Barbara wishes to invest in the KAPCO Growth Fund, an open-end investment company. She expects to hold the shares for at least 10 years. If she purchases KAPCO's Class A shares, each of these would be a way for her to receive a reduction on the sales charge except A. a single investment that reaches a breakpoint. B. joining together with her sister to make a purchase at a breakpoint level. C. signing a letter of intent. D. benefiting from the right of accumulation.
B. joining together with her sister to make a purchase at a breakpoint level. Reaching a breakpoint is the way in which investors can receive a "break" on the sales load charged when purchasing Class A shares. Purchases may be combined with spouses and dependent children, but not other family members, such as siblings, making the exception here. The three ways to reach a breakpoint are: - a lump-sum purchase; - using a letter of intent granting 13 months to reach the breakpoint; or - taking advantage of rights of accumulation (no time limit).
When discussing investment companies, the term sales load most commonly refers to A. the fund's sales charge, expressed as a percentage of the NAV. B. the fund's sales charge, expressed as a percentage of the public offering price. C. the commission earned by the broker-dealer making the sale. D. the 12b-1 fee.
B. the fund's sales charge, expressed as a percentage of the public offering price. Class A shares of an open-end investment company (mutual fund) have a "front-end" sales charge, or sales load, which is computed as a percentage of the public offering price. That is, if the fund's POP is $10 and the NAV is $9.50, the 50-cent sales charge is 5% of the $10 offering price. In general, the majority of the sales load is paid to the broker-dealer making the sale as compensation. The 12b-1 fee is never referred to as a sales load because it is not related to the sale of shares. However, you will see the phrase asset-based sales charge.
You may be required to know what hedge funds and mutual funds have in common. Which of the following would you choose? A. A high degree of transparency B. Relatively low management costs C. A pooled investment with other investors D. High liquidity
C. A pooled investment with other investors From what we've covered, you should have seen that hedge funds do not offer the transparency of mutual funds. The key to getting that point is that they are not registered with the SEC, so the disclosures that must be made are limited. The management fees for hedge funds are much higher than mutual funds and, due to the lock-up period, their liquidity is questionable. However, the common characteristic is that they are pooled investments.
ABC is an FINRA member broker-dealer. Among other functions, it serves as the principal underwriter of the XYZ Mutual Fund. Which of the following transactions of ABC would be prohibited? A. ABC tenders, from its investment account, 500 shares of the XYZ Mutual Fund for redemption. B. ABC purchases, for its investment account, 500 shares of XYZ Mutual Fund. C. ABC purchases some securities directly from XYZ's portfolio. D. All of these.
C. ABC purchases some securities directly from XYZ's portfolio. It would be a violation of the Investment Company Act of 1940 for any affiliated person, such as the principal underwriter, to purchase any security from an investment company other than shares of the fund itself. Investing in the fund's shares would be permitted, not prohibited.
When discussing the advantages of mutual funds, it is permissible to point out that they offer A. better performance than investing in individual securities. B. tax advantages not available to the individual investor. C. diversification and professional management. D. lower expenses than "do-it-yourself" investing.
C. diversification and professional management. The two primary advantages of mutual funds are diversification and professional management. If the investor in individual stocks happens to pick a few real winners, the performance will likely exceed that of a mutual fund. There is no general yes or no on that. Some would say that individual investments offer more tax advantages because the investor selects when and what to sell. Although the mutual fund will typically pay less in trading costs than an individual investor, the other expenses, especially the management fee, can make investing in mutual funds more expensive than selecting securities on your own.
As described in the Investment Company Act of 1940, the term management investment company include A. face-amount certificate companies, unit investment trusts, and open-end and closed-end investment companies. B. unit investment trusts and open-end and closed-end investment companies. C. open-end and closed-end investment companies. D. growth funds and income funds.
C. open-end and closed-end investment companies. The act describes three kinds of investment companies: FACCs, UITs, and management companies. Management companies are divided into two types: open end and closed end. The definition in the act does not list different objectives, such as growth and income.
Which of the following types of investment company is permitted to capitalize with common stock and preferred stock? A. A balance fund B. A unit investment trust C. An open-end investment company D. A closed-end investment company
D. A closed-end investment company One of the unique characteristics of closed-end companies (CEFs) is that they can issue common stock, preferred stock, and debt securities. Note that this question is not asking about the portfolio contents; it is asking about the kinds of securities the company can issue to raise capital.
One of your clients wishes to invest in a hedge fund. You should explain which of the following points? A. Shares of these funds are easy to redeem. B. The fund can be expected to generate a profit whether the markets trend up or trend down. C. These funds purchase a large amount of preferred stock. D. Expenses for these funds tend to be higher than those for traditional mutual funds.
D. Expenses for these funds tend to be higher than those for traditional mutual funds. Hedge funds typically use risky strategies to generate profit regardless of market direction, but there is no assurance that the objective will be realized. Redemption may be difficult with these funds, and higher management fees make for higher expenses than traditional mutual funds.
Identify two trading strategies that a hedge fund can employ in its portfolio but a mutual fund cannot. I. Limiting investments to a narrow group of securities within one industry II. Trading on margin to purchase portfolio securities III. Purchasing speculative or low-rated securities IV. Short selling of stock A. I and III B. I and IV C. II and III D. II and IV
D. II and IV While there can be limited and rare exceptions, mutual funds are prohibited from purchasing securities on margin and selling securities short. Both strategies, however, are commonly employed by hedge funds.
Which of the following statements correctly expresses requirements under the Investment Company Act of 1940? I. A registered open-end investment company using a bank as custodian must choose one that has FDIC coverage. II. If an affiliated person of a registered investment company wishes to borrow money from the fund, there must be at least 300% asset coverage. III. No investment advisory contract may be entered into that does not provide for termination with no more than 60 days' notice in writing. IV. No registered investment company may acquire more than 3% of the shares of another investment company. A. I and II B. I and IV C. II and III D. III and IV
D. III and IV The Investment Company Act of 1940 requires that all advisory contracts contain a provision that the contract may be terminated upon no more than 60 days' notice in writing, choice III. The act prohibits any registered investment company from owning more than 3% of the shares of another investment company, choice IV, making choice D the correct answer. There are no circumstances under which an affiliated person can borrow from the fund, and it is not a requirement that the custodian bank have FDIC insurance.
Julia, an analyst for a large investment advisory firm, is analyzing various policies utilized by hedge funds recommended by her firm. Julia has summarized the policies as follows: - Policy 1 During the fundraising period, each new investor must contribute a minimum of $500,000 to the fund. - Policy 2 The hedge fund manager will return incentive fees to investors in the event that the minimum required return is not met. - Policy 3 Investors must provide redemption requests to the hedge fund manager at least 60 days before the funds are to be withdrawn. - Policy 4 New investors may not withdraw funds during the first 6 months that the funds are invested with the hedge fund manager. Which of the policies identified by Julia specifies a lock-up period? A. Policy 1 B. Policy 2 C. Policy 3 D. Policy 4
D. Policy 4 A lock-up period refers to a set period of time, such as 6 months, that an investor's funds must remain invested in the hedge fund. During that time period, withdrawal requests are not permitted.
Louis owns an investment that is an unmanaged portfolio in which the money manager initially selects the securities to be included in the portfolio, and then holds those securities until they mature or the investment portfolio terminates. This statement best describes which type of investment? A. Closed-end investment company B. Face-amount certificate company C. Open-end investment company Unit investment trust D. Unit investment trust
D. Unit investment trust A unit investment trust (UIT) is a type of investment company which is generally unmanaged as the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the UIT terminates
One of your friends is an entrepreneur who is looking for a way to raise capital for her fledgling business. Because the enterprise has no operating history, it is most likely that her best bet would be to approach A. a hedge fund. B. a mutual fund. C. a private equity fund. D. a venture capital fund.
D. a venture capital fund. When a business is in the pre-operating stage, it is of most interest to venture capitalists. Private equity funds, including hedge funds, invariably invest in going concerns, and mutual funds are almost always limited to purchasing securities that are marketable.
