STC Series 7 Chapter 9, 10, and 11: Investment Companies, Variable Products, and Alternative Products

Describe: Inverse ETFs and Leveraged ETFs?

* Lately, specific types of ETFs—inverse and leveraged ETFs—have become popular among investors. Inverse ETFs attempt to go up when the market drops or go down when the market rises. Leveraged ETFs seek to provide a multiple of the return on a benchmark index. Inverse ETFs: designed to perform as the inverse of the index it's tracking. This reverse tracking is accomplished through the use of short selling the underlying investments in the index and other advanced strategies using futures and derivatives. The goal of the inverse ETF is to yield performance that's equivalent to short selling the stocks in the index. For example, if the S&P 500 falls by 1.5% on a given day, the inverse ETF should rise by approximately 1.5%. These products are often used by long investors to hedge against a bear market. Inverse ETFs provide investors with a benefit over traditional short selling strategies. When selling short, an investor is exposed to a potential unlimited loss; however, with an inverse ETF, the investor is only exposed to a potential loss of the instrument's purchase price (i.e., ETFs offer limited liability). Leveraged ETFs: products that use debt instruments or financial derivatives such as swaps, futures, and options to amplify the returns of a specific index. These leveraged products may be constructed to either track the specified index or an inverse of the index. For example, a leveraged long ETF may be designed to deliver 2 times or 3 times the performance of the S&P 500 (referred to as double-long or triple-long ETFs). A leveraged bear ETF may be designed to deliver the inverse of 2 times or 3 times the performance of the S&P 500 (referred to as double-short or triple-short ETFs).

Who do we make Breakpoints, Letters of Intent, and Rights of Accumulation available to?

- An individual purchaser - A purchaser's immediate family members (i.e., spouse and dependent children) - A fiduciary for a single fiduciary account - A trustee for a single trust account - Pension and profit-sharing plans that qualify under the Internal Revenue Code guidelines - Other groups, such as investment clubs, provided they were not formed solely for the purpose of paying reduced sales charges. Remember, only purchasers of Class A shares are eligible for breakpoints; therefore, large purchasers of funds should not be placed into Class B shares. Before mutual fund shares are purchased by a client, an RR must inquire as to whether the client owns other mutual funds within the same fund family in a related account—even if the account is held by another broker-dealer. For example, a minor's account, a joint account, and an IRA could be combined with an individual account when determining the appropriate breakpoint on a new purchase. For a fund to assess the maximum allowable sales charge of 8.5%, it must offer investors both breakpoints and rights of accumulation. If the fund omits either of these features, the maximum sales charge it's permitted to assess is lowered according to a set schedule.

As it relates to mutual funds, which events are taxable?

- Receiving dividends - Reinvesting dividends - Exchanging shares (within a fund family) - Switching shares (outside a fund family)

When are variations in sales loads allowed?

- The fund applies the variations uniformly to all of the potential purchasers of its shares - Adequate information concerning scheduled variations is given to shareholders and prospective investors - The prospectus is revised if schedules are changed - The company advises its existing shareholders of any new variations within one year

Describe some mutual fund terminology?

- The sales charge is also referred to as the sales load. - The net asset value (NAV) is also referred to as the redemption or bid price. - The public offering price (POP) is also referred to as the net asset value plus the sales charge (if any)

Describe the three types of REITs?

1. Mortgage REITs provide funding to real estate purchasers by acting in the same capacity as a bank. Mortgage REITs borrow funds from investors and then invest the funds in mortgages and typically earn income based on the difference between these two rates of interest (which is referred to as the spread). 2. Equity REITs own and operate income-producing real estate, such as apartment buildings, commercial property, shopping malls, vacation resorts, and other retail properties. 3. Hybrid REITs These business structures are a combination of mortgage REITs and equity REITs. By purchasing a hybrid REIT, the investor can take advantage of buying a security that invests in the actual equity ownership of real estate as well as investing in an interest-rate sensitive security (i.e., the mortgage REIT).

Describe the following in relation to Mutual Funds: Letter of Intent (LOI)?

A letter of intent enables an investor to qualify for a discount made available through breakpoints without initially depositing the entire amount required. The letter indicates the investor's intention to deposit the required money over the next 13 months and is able to be backdated for 90 days. Since letters of intent are non-binding, an investor will not be penalized for failing to make the additional investments. However, if investors fail to make the additional investments, they're charged the amount that equals the higher sales charge that applied to the original purchase. Basically, if a person fails to invest the amount stated in the LOI, the fund will retroactively collect the higher fee.

At dissolution of a partnership, what is the LP considered and whats the priority for liquidation?

A limited partner who has committed capital may also extend a loan to the partnership. If the partnership declares bankruptcy, the LP is considered a limited partner for the capital contribution and a general creditor for the amount of the loan. At dissolution of a partnership, state law provides the following priority for settling accounts: 1. Secured creditors 2. General creditors 3. Limited partners 4. General partners

What are Advantages of Variable Life Insurance Policies?

A significant advantage of variable life insurance policies is the ability to invest some of the premium payments into subaccounts that contain stocks or other assets that have historically paid high returns over the long term. These types of investments give policyholders the potential to grow their cash value and death benefits, and may help protect policyholders and their beneficiaries from the negative effects of inflation.

Describe the two different types of variable annuities?

A variable annuity may be classified according to the point at which annuity payments are to begin. The two classifications are immediate annuities and deferred annuities. Immediate Annuities: these annuities begin payments to the annuitant one payment period after a lump-sum deposit has been made to fund the annuity. If the contract calls for monthly payments, these payments to the annuitant will begin one month after the date of purchase. If the contract calls for annual payments, these payments will begin one year after the date of purchase. An immediate annuity may only be funded with a single premium since the payments will begin shortly after the contract is purchased. Deferred Annuities: these annuities delay payments to the annuitant for an undetermined period after the date of purchase. The first payment may begin several years after the money is deposited. A deferred annuity may also be funded with a single premium, but most are funded with periodic payments. Premiums may be deposited in the annuity monthly, quarterly, semi-annually, or annually. For Series 7 Examination purposes, if not specified, it should be assumed that the questions are referring to non-qualified deferred contracts which are funded with after-tax dollars.

Describe the Suitability Obligation of a RR who sells a Limited Partnership?

According to industry rules, a representative who sells the offering must make inquiries to ensure that a purchaser understands the ramifications of the investment. This assurance may be accomplished through the subscription agreement which normally states that the purchaser: - Has read the prospectus or offering memorandum - Understands the risks associated with the investment - Has access to advice - Has met all net worth, income, and suitability requirements The subscription agreement also specifies which parties must sign the contract. In most cases, this is both the general partner and the limited partner. By signing the agreement, the customer is verifying that she meets all suitability standards. Subsequently, the customer is often required to furnish documents, such as past tax returns and a statement of net worth, to demonstrate that she meets the eligibility thresholds for investment purposes.

What Factors are Used to Determine the Number of Annuity Units?

Age and Life Expectancy: Since an annuity typically promises a payment for life, the insurance company needs to use a person's current age and gender to estimate how long the payments will need to be made. For example, on average, it may be assumed that a 65-year-old woman will live for another 20 years. If payments are to be made monthly, it would require 240 monthly payments. Therefore, the insurance company credits the account with 240 annuity units. The value of those units is then based on how the funds in the account have accumulated and the manner in which they will be paid out. On the other hand, if an 80-year-old man decides to annuitize, his remaining life expectancy will be much shorter. The insurance company may assume he will live for only five years and, correspondingly, his annu

Describe the different types of (High Risk Category Funds) and the clients for whom they're suitable?

Aggressive Growth Funds: invest in small companies and often participate in the initial public offerings of these companies' shares. The stocks of these companies can be very volatile, but historically they have also produced high returns for long-term investors. These funds are best suited for younger, risk-taking investors who can tolerate the swings in value and the fact that these holdings generally don't provide income (dividends). Specialized or Sector Funds: concentrate their investments to stocks in a particular industry (e.g., high tech stocks or pharmaceuticals) or in a particular geographic location. Specialized funds invest in companies that are undergoing some type of change, such as bankruptcy. Although specialized funds are riskier than more diversified funds, they allow fund managers the opportunity to take advantage of unusual situations. These funds are most appropriate for investors who are seeking to speculate on a given sector of the economy (e.g., gold, housing, etc.) For example, precious metal funds invest in companies whose values are connected to gold, silver, or other precious metals, or may invest directly in the actual metals. International and Global Funds: mutual funds that focus on foreign securities are often the easiest way for U.S. investors to invest abroad. International funds invest primarily in the securities of countries other than the United States. They include funds that invest in a single country and regional funds that invest in a particular geographic region (e.g., Europe or the Pacific Basin). On the other hand, global funds invest all around the world, both in the U.S. and abroad. International funds have more risks than purely domestic funds, but also have the potential to provide higher returns and allow U.S. investors to diversify their portfolios. One particularly volatile type of international fund is an emerging markets fund. These funds invest in the stocks and bonds of emerging market countries that are evolving from an undeveloped agricultural economy to a modern industrial one (e.g., Brazil), or from a socialist economy to a free market system (e.g., Eastern Europe and Russia).

Define & describe: Closed-End Investment Companies?

Along with open-ends, closed-end investment companies are the other type of management company. Unlike open-end management companies (mutual funds), closed-end funds usually issue common shares to the public on a one-time basis. Although they may issue additional shares later, they don't continuously issue new shares or stand ready to redeem their shares for cash. While it's typical for closed-end funds to issue common shares, some may issue senior securities (i.e., preferred stock or bonds). Once a closed-end investment company issues shares, these securities trade in the secondary market. Therefore, if an investor wants to purchase shares in a closed-end investment company, he will need to buy them on a traditional exchange (e.g., the NYSE or Nasdaq). There's no prospectus delivery requirement that applies to secondary market trades of closed-end funds. The price that an investor pays for his shares is determined by the market forces of supply and demand. Unlike mutual funds, closed-end funds may trade at prices that are at a discount or a premium to their NAV. When closed-end funds are purchased or sold in the secondary market, the investors are subject to commissions rather than sales charges.

Describe the structure of a mutual fund & components of the fund?

Although most mutual funds are organized as corporations, some are established as trusts. In many ways, the structure of a mutual fund resembles a regular corporation. It has a board of directors that's responsible for administering the fund for the benefit of the shareholders. The shareholders are the persons who invest money in the mutual fund. Board of Directors: elected by its shareholders. The board's main functions are to protect the shareholders' interests and to be responsible for: - Establishing the fund's investment policy (any fundamental changes in the policy must be approved by shareholders) - Determining when the fund will pay dividends and capital gains distributions to shareholders - Appointing the fund's principal officers who run the fund on a day-to-day basis (e.g., the investment adviser that manages the fund's portfolio) - Selecting the fund's custodian, transfer agent, and principal underwriter Investment Adviser: manages the fund's portfolio in accordance with its investment objectives and the policies established by its board of directors. The adviser researches and analyzes financial and economic trends and then decides which securities the fund should buy or sell in order to maximize its performance. The adviser is also responsible for ensuring that the fund's assets are properly diversified and for tracking the tax status of the fund's distributions to its shareholders. For these services, the investment adviser is paid a management fee that's based on the assets under management, but not on performance. The management fee is the largest expense incurred by an investment company. Fund advisors are typically prohibited from employing certain aggressive trading strategies such as short selling and the use of margin. Custodian Bank: in order to prevent the theft or loss of a fund's assets, the Investment Company Act requires the fund to either appoint a qualified bank as its custodian or maintain its assets under a very strict set of rules. Most funds choose to appoint a bank to act as their custodian. The custodian is responsible for safeguarding the fund's cash and securities and collecting dividend and interest payments from these securities. However, the custodian doesn't guarantee the fund's shareholders against investment losses, nor does it sell shares to the public. A fund's custodian may also serve as its transfer agent. Transfer Agent: transfer agent performs a number of record-keeping functions for the fund, such as issuing new shares and canceling the shares that investors have redeemed. Today, most of these securities functions are done electronically without physical certificates changing hands. The transfer agent also distributes capital gains and income dividends to the fund's shareholders, and often handles the mailing of required documents such as statements and annual reports. A transfer agent may be a brokerdealer or have a broker-dealer as a subsidiary. If this is the case, any information that the broker-dealer or its representatives acquire regarding the fund(s) for which it serves as a transfer agent may not be used without the permission of, and on behalf of, the fund itself. Principal Underwriter: most funds use a principal underwriter, also referred to as the sponsor, wholesaler, or distributor, to sell their shares to the public. An underwriter may sell shares directly to the public or it may employ intermediaries (dealers) such as a discount or full-service brokerage firm. Many funds use a network of dealers to market their funds to investors. The dealers are essentially brokerage firms that have a written contract with the underwriter and are compensated for selling shares of the fund to investors. A FINRA member firm may not sell fund shares at a discount to a nonmember firm since only member firms may receive sales charges.

Define & describe: Real Estate Investment Trusts (REITs)?

Although real estate investment trusts have features that are similar to investment companies, these products are not categorized under the Investment Company Act of 1940. However, the Securities Act of 1933 regulates REITs as securities and requires the sending of prospectuses to any investors who acquire the shares through public offerings conducted in the primary market. REITs create a portfolio of real estate investments from which investors may earn profits. REITs invest in many different types of residential and commercial income-producing real estate, such as apartment buildings, shopping centers, office complexes, storage facilities, hospitals, and nursing homes. Income is received from the rental income being paid by tenants that leases the real estate which is owned by the REIT. These investments are actually suitable for both retail and institutional investors.

Define & describe: Annuities?

An annuity is an agreement between a contract owner and an insurance company. The owner gives the insurance company a specific amount of money and, in return, the company promises to provide a person (i.e., the annuitant) with income either immediately or at some point in the future. The contract owner may designate any person as the annuitant; however, the annuitant and the contract owner are usually the same person. Most annuitants choose to start receiving their income payments when they retire. Annuities are typically considered long-term investments which many clients use to supplement their work-sponsored retirement plans and/or their IRAs. A significant benefit offered by annuities is that the growth in the accounts is tax-deferred. However, two drawbacks are that purchasers of these investments often have long holding periods and they may be subject to significant surrender charges and/or tax liabilities if assets are withdrawn too quickly. From an investor's standpoint, many of these contracts have features that can be confusing.

Define & Describe: Investment Companies?

An investment company pools funds from numerous investors and purchases securities that are held in a portfolio for the benefit of those investors.

Describe the following in relation to Mutual Funds: Redeeming Shares?

An investor who currently owns shares in a mutual fund may redeem (sell) those shares back to the fund on any business day. Since shares are redeemed at the NAV, a fund must calculate its NAV at least daily; however, some funds may do the pricing more frequently. The Investment Company Act of 1940 requires mutual funds to pay the redemption proceeds to their investors within seven calendar days.

Describe Withdrawals During the Annuity Period?

Annuitizing a Non-Qualified Contract When a non-qualified contract is annuitized, the annuitant begins to receive periodic payments. For tax purposes, these periodic payments are divided into the following two parts: 1. An amount that represents the original investment in the annuity 2. The remainder which represents investment income On each annuity payment, the annuitant is only taxed at her ordinary rate on the amount of the payment that represents investment income. Once the total amount of non-taxable income received equals the investor's cost basis, the entire amount of any future payments is taxable as ordinary income. Annuitizing a Qualified Contract A qualified annuity is funded with pre-tax contributions that are deducted from the employee's paycheck. These funds subsequently grow on a tax-deferred basis. Therefore, when a qualified contract is annuitized, the entire payment will be taxable as income. Remember, since the contributions were made pre-tax, the contract holder has a zero cost basis.

Describe the following in relation to Mutual Fund Taxation: Income?

Any distribution of taxable bond interest and cash dividends on common stock must be reported as ordinary income and is taxed at an appropriate rate. Realized short-term capital gains are included with mutual fund dividends on an investor's tax return and are taxed as ordinary income. As with other equity securities, cash dividends from mutual funds may be non-qualified or qualified. Non-qualified dividends are taxed at the individual's ordinary tax rate. Qualified dividends are taxed at the long-term capital gains tax rate (i.e., a maximum of 20%). For a dividend to be qualified, the mutual fund must have held the shares on which the dividend is paid for more than 60 days, and the investor must also have held the shares for more than 60 days.

Is the Prospectus Delivery a Requirement?

Any offer to sell a fund's shares must either be preceded by or accompanied by the current prospectus. The delivery may be made in physical or electronic form. Dealers must have systems in place to ensure that clients receive this document before any purchase orders are processed. Also, RRs are not permitted to alter a prospectus in any way. This restriction prohibits a salesperson from underlining or highlighting the information he considers to be the most relevant.

Describe the following in relation to Mutual Fund Taxation: Capital Gains and Losses?

As with other capital assets, capital gains and losses on mutual fund shares are calculated by subtracting the cost basis of the shares from the sales proceeds received when they're sold (redeemed). Of course, unrealized gains or losses are not included in this calculation. An investor who redeems mutual fund shares receives a report of the sales proceeds at the year-end on Form 1099-B. Using her account records (e.g., confirmations and statements), the investor is responsible for determining the cost basis of the shares being sold. Whether a gain or loss is deemed to be long-term or short-term is based on the length of time the investor owned the shares prior to sale (redemption). On the other hand, whether a capital gains distribution made by a mutual fund is deemed to be long-term or short-term is based on the length of time the fund held the individual position prior to its sale. Since this situation involves the fund selling shares in its portfolio, the investor's holding period is irrelevant.

Once the insurance company determines its future payout requirements, it uses an Assumed Interest Rate (AIR). Describe it!

Assumed Interest Rate (AIR) Once the insurance company determines its future payout requirements, it uses an assumed interest rate to project the return over the payout (annuity) period. The AIR is NOT a minimum or guarantee—it's simply used as part of the actuarial calculation. The AIR is the rate of interest that's stated in the contract and used to determine the first annuity payment. Going forward, it then becomes the benchmark for determining subsequent payments. Annuitants are able to choose from various assumed interest rates when annuitizing their contracts. The maximum AIR is regulated by the state. If a high AIR is chosen, the challenge is that it will be more difficult to achieve a return that exceeds the AIR. If the AIR exceeds the account's actual performance, the annuity payment will decrease. After the initial payment, the insurance company calculates each subsequent monthly payment by multiplying the fixed number of annuity units on which the client is receiving payments by the current value of an annuity unit (a fluctuating value). The actual value of the annuity units will change based on the performance of the investments in the separate account. The annuitant's future payments depend on the relationship between the AIR and the actual performance of the separate account as summarized below: - If separate account performance is equal to the AIR, the annuitant's payment will remain the same as the previous payment. - If separate account performance exceeds the AIR, then the payment will be higher than the previous payment. - If separate account performance is less than the AIR, the payment will be lower than the previous payment.

Name a Few Prohibited Sales Practices? Describe them!

Breakpoint Sales: RRs who induce clients to purchase shares at a level just below the dollar value at which a breakpoint is available are engaging in a prohibited practice that's referred to as a breakpoint sale. Instead, clients should be reminded that LOIs may be used if all of the funds are not currently available. Also, RRs should avoid allocating a client's investments into several different fund families. This practice may result in the client not receiving a breakpoint that would have been available if all the funds were allocated to a single family. Selling Dividends: RRs are prohibited from pressuring clients to immediately purchase mutual fund shares in order to capture an impending dividend. Essentially, there's no economic benefit for a customer since, once the dividend is paid, the fund's NAV will fall. Also, by receiving the dividend, the customer will be required to pay taxes on the distribution. Switching: Regulators are always on the lookout for abusive sales practices. When an RR recommends that a client sell the existing mutual fund shares she owns of one fund family and invest the proceeds into a fund of another family, a new sales charge will be levied. The concern is that the movement between different fund families is being recommended by an unscrupulous RR who is seeking to generate income at the client's expense. Remember, the movement between funds of the same family is not typically a sales practice concern since the client is not required to pay an additional sales charge. Purchasing Large Quantities of Class B Shares: RRs should not recommend buying Class B shares to a client who intends to place a large order. The client would derive a greater benefit by purchasing Class A shares since only these shares qualify for breakpoints.

What are the different types of Management Companies?

Closed-end companies AND Open-end companies. Open-end management companies= mutual funds

Define & describe: Direct Participation Programs (DPPs)?

Direct participation program is a type of investment in which the results of the business venture (cash flow, profits, and losses) directly flow through to the investors. DPPs come in different forms, such as general partnerships, joint ventures, & Subchapter S Corporations. Subchapter S Corporation is a type of small corporation (one with 100 or fewer shareholders) that meets the requirements of Subchapter S of the IRC. S Corporations are not taxable entities; instead, their profits and losses are passed through to their shareholders (i.e., the shareholders report their portion of profits and losses on their individual income tax returns). At a minimum, a limited partnership simply requires two partners—one general partner and one limited partner. General Partner (GP) is responsible for managing the program and must contribute at least 1% of the program's capital. Limited Partner (LP) is a passive investor who has no control over managerial decisions. Instead, limited partners are typically relied on to contribute a large amount of the program's capital.

Name some of the advantages offered by mutual funds? Describe them!

Diversification: Diversification allows investors to reduce their risk by spreading their money among many different investments. A management company may be either diversified or nondiversified. In order to qualify as a diversified company, the portfolio must be invested in the following specific manner: 1. At least 75% of the assets must be invested. 2. No more than 5% of the invested assets may be invested in any one company. 3. No more than 10% of the voting stock of any one company may be owned. A diversified company must meet these standards at the time of initial investment; however, subsequent market fluctuations or consolidations will not nullify its diversified status. Professional Management: Most retail investors don't have the time or expertise to manage their own investments adequately and cannot afford to hire their own professional manager. By investing in mutual funds, the investors receive the services of professional managers for much less than they would need to pay individually. These money managers must be registered as investment advisers under the Investment Advisers Act of 1940. Liquidity: Mutual funds are highly liquid investments; however, unlike standard stocks, mutual fund shares are not traded throughout the day. Instead, mutual fund shares are issued and able to be redeemed at the end of each trading day. Exchanges at Net Asset Value: shareholders may often exchange their shares own in one fund for shares of another fund within the fund family at the net asset value (the fundamental value of the shares). No sales charges will be assessed on the reallocation. Convenience: A person who wants to invest a fixed sum of money every month may arrange to have the funds automatically deducted from their checking accounts. Investors are also able to have their income dividends and capital gains reinvested automatically. Recordkeeping: Mutual funds provide a number of services that make investing easy. The fund takes care of most of the record-keeping and ensures that shareholders receive regular reports that show their purchases and redemptions as well as end-of-the-year tax summaries (Form 1099-DIV). Mutual funds also must send detailed financial reports to their shareholders at least twice per year. These semiannual and annual reports provide the shareholders with the most current information about the fund's finances and holdings as of a particular date. SEC Registration: The Investment Company Act of 1940 requires every investment company that has more than 100 shareholders to register with the Securities and Exchange Commissions (SEC). (There's an exception if all of the shareholders meet certain financial tests that make them qualified investors.) Also, a fund must have a minimum net worth of $100,000 in order to offer its shares to the public.

Describe the following in relation to Mutual Funds: Dollar Cost Averaging (DCA)?

Dollar cost averaging is a popular method of investing in mutual funds in which a person invests a fixed-dollar amount at regular intervals, regardless of the market price of the shares. An investor who uses dollar cost averaging is ultimately buying more shares when the price is low and fewer shares when the price is high. The result is that the investor's average cost per share is lower than the average of the prices at which the investor purchased shares. For example, an investor commits to purchasing $100 worth of XYZ Fund shares each month for three months. In month one, the shares are trading at $25 and four shares are purchased. In month two, the shares are trading at $20 and five shares are purchased. Finally, in month three, the shares are again trading at $25 and four shares are purchased. What's the average cost per share and the average price per share? When discussing dollar cost averaging in reference to a periodic payment plan, the following points must be made clear: - At redemption, investors will sustain a loss if the market value of the shares is below the total cost of the shares. - Investors must take into account their ability to continue the plan in periods of low prices and their willingness to continue the plan regardless of price levels. - The plan doesn't protect investors against losses in steadily declining markets. Dollar cost averaging lessens the risk of investing a significant amount of money at the wrong time and is considered particularly appropriate for long-term investors, such as those investing for retirement

Describe the Accumulation Period of Variable Annuities? Accumulation Units, Cash Surrender Value, and Death Benefit?

During the accumulation, funding or pay-in period, the owner makes payments to the insurance company and the value of the annuity account begins to grow (accumulate) on a tax-deferred basis. While mutual fund investors buy shares, customers investing in variable annuities buy accumulation units. Accumulation units are an accounting measurement used to determine the annuitant's ownership interest in the separate account. The value of each unit is tied to the performance of the separate account. If the separate account performs well, then the units will increase in value. If performance is poor, the value of the units will decrease. Accumulation Units: clients buy accumulation units at their net asset value (NAV), but are normally subject to a deferred sales charge. The NAV of the subaccount units is calculated in the same manner as the NAV of a mutual fund. The NAV of each unit is calculated at the end of every business day (usually at the close of trading on the NYSE). As with mutual funds, both liquidations and purchases of annuities use the same end-ofday forward pricing method. To find the current value of a person's interest in the separate account, the number of accumulation units owned is multiplied by the current value of each accumulation unit. Provided an investor doesn't withdraw money from her annuity, she has no tax liability from either the dividends or interest generated by the securities positions within the subaccounts. Also, any switches executed between subaccounts are tax-free. NAV Per Unit = Total Net Assets / Total Units Issued Cash Surrender Value: at any time during the accumulation period, a contract owner may cancel (surrender) her variable annuity and be returned its current value. She may also simply choose to withdraw a portion of its value (a partial surrender). If withdrawals are taken, the contract owner is required to pay taxes on any increases in the value of her annuity and may be subject to a tax penalty (if she's under the age of 59 1/2) on all amounts withdrawn. Death Benefit: although variable annuities are not life insurance policies, they often provide a death benefit. The contract owner designates a beneficiary and, if the annuitant dies during the accumulation period, the beneficiary receives the greater of either (1) the sum of all of the contract owner's payments to the annuity or (2) the value of the annuity on the day the annuitant dies. Because mutual funds lack this feature, this is one reason that clients may prefer to purchase annuity contracts despite the fact that they're relatively more expensive.

Define & describe: Exchange-Traded Funds (ETFs)?

ETFs issue shares each of which represent an interest in an underlying basket of securities that mirror a specific index. Some ETFs may also be linked to indexes that represent the securities of a particular country or industry. Some examples of ETFs include: - SPDRs (Spiders), which tracks the S&P 500 Index - QQQs (Cubes), which tracks the Nasdaq 100 Index - DIA (DIAMONDS), which tracks the Dow Jones Industrial Average Many investors actively trade ETFs because they think they're better able to estimate the overall direction of the market or a sector, rather than trying to do the same for an individual stock that's more susceptible to unexpected news events. Other investors buy and hold ETFs, just like mutual fund shares in a retirement account. Bond ETFs often manage a large portfolio and reinvest the proceeds from maturing bonds into new bonds. These products provide investors with professional money management. There are a number of ways that ETFs are unlike mutual funds, such as the fact that they're traded on an exchange, have prices that are determined continuously by the forces of supply and demand, have lower expenses, may be sold short, and may be purchased on margin. Additionally, rather than being assessed sales charges, investors pay commissions whenever ETFs are purchased or sold. An ETF may be an appropriate investment for customers who are investing a lump-sum and are seeking diversification and low costs. They may also be suitable for investors intending to implement asset allocation plans.

Describe: Forward Pricing?

End of Day Pricing/ Forward Pricing: orders to buy and sell fund shares are based on the next price to be computed. Referred to as forward pricing since purchases and redemptions are based on the next calculated price. For example, if an individual places an order to purchase shares at 11:00 a.m., the purchase price will not be known until the net asset value is computed after the close of business on that day. If a client places an order at 4:10 p.m. on Wednesday (after the close), the order will not be executed until the close of business on Thursday. This end of day pricing is an important distinction between mutual funds and other types of funds, such as ETFs. ETFs trade throughout the day and use intraday pricing in a manner that's identical to individual stocks.

Describe the regulation of variable products?

FINRA rules that govern the sale of variable products are similar to those for investment companies. As mentioned previously, although variable products are issued by insurance companies, they're considered securities and are regulated by federal securities laws and must be delivered with a prospectus. Persons who market these products must hold a valid Series 6 or Series 7 registration as well as a state insurance license. The separate accounts of variable products are generally required to be registered as investment companies under the Investment Company Act of 1940. Selling Agreements FINRA members that are the principal underwriters of variable products may not sell them through another broker-dealer unless that firm is also a FINRA member. As is the case with mutual fund trades, there must be a selling agreement in effect between the underwriter and the broker-dealer. This agreement must state that if a client cancels the contract within seven business days after the application is accepted, the broker-dealer will return the sales commission to the insurance company that issued the contract. Applications and Premium Payments A FINRA member must promptly transmit all applications for variable life insurance policies or variable annuities to the insurance companies that are issuing the contracts. A firm must also promptly send the issuer the portion of a client's premium (purchase) payments that are supposed to be credited to the contract. The exact price (NAV) of the shares of a subaccount being purchased by a policy owner must be determined after the issuer receives the owner's premium payment. The NAV calculation must be done in accordance with the product's contract, its prospectus, and the Investment Company Act of 1940. Cash Surrender A FINRA member firm is prohibited from selling variable contracts that are issued by an insurance company that doesn't promptly pay clients who surrender (cash in) all or part of their contracts.

Advantages of Limited Partnerships? Name them, then describe them!

Favorable Tax Treatment Unlike corporations, partnerships are not taxable entities. Instead, the partnership's income (or loss) is allocated directly to the partners for tax treatment on their personal income tax returns (i.e., it's passed through and reported as passive). Any passive income that's distributed is taxed as ordinary income. However, beginning in 2018, the new tax law impacts the taxation of passive income by providing the same two benefits that investors receive with REITs: 1. Of the income passed through by the partnership, 20% of it is deductible (excluded from tax). 2. The maximum tax rate on ordinary income has been lowered to 37% (from 39.6%). Therefore, since 20% of the passive income from partnerships is deductible, the effective tax rate for investors who are in the highest tax bracket is 29.6% (37 x 80% = 29.6%). Since the business doesn't pay tax, limited partners may receive more income from a profitable DPP than from a profitable corporation. This is due to the fact that a corporation's dividends are paid as after-tax distributions. Essentially, the corporate level of taxation is removed from the tax equation. Limited Liability Another benefit of structuring a program as a limited partnership is limited liability for the LPs. Limited partners assume financial risk only to the extent of their investment in return for a share in the project's income and deductions. In other words, limited partners cannot lose more than the amount that they have at risk. Diversification Many limited partnerships invest in assets that have little or no correlation to the stock and bond markets. These programs may provide an investor with a level of diversification that may not be available from traditional packaged product offerings (e.g., mutual funds).

What are two sub-categories of annuity contracts?

Fixed & Variable With a fixed contract, the investment risk is borne by the insurance company; however, with a variable contract, the owner of the policy assumes all of the investment risk. For this reason, fixed contracts are not considered securities and are governed under state insurance law only. On the other hand, variable contracts are considered securities and are subject to SEC, FINRA, and state insurance regulation. As is the case with all variable products, a prospectus must be delivered prior to completing the sale of any variable annuity.

Define & describe: Fixed Annuities? Suitability & Regulation?

For a fixed annuity, the money being contributed is invested by the insurance company in its general account. This general account is the portion of an insurance company's asset base into which traditional policies such as whole life, term life, and other lower-risk investments are placed. With fixed annuities, insurance companies guarantee a minimum rate of return and agree, if the customer chooses, to provide fixed-dollar payments for potentially the rest of the annuitant's life. Fixed Contract Suitability: since the insurance company is obligated to pay the annuitant regardless of how its investments perform, the insurance company assumes all the investment risk in a fixed annuity. An annuitant must feel secure in knowing that she will regularly receive the same amount of money for the remainder of her life (assuming the insurance company remains financially healthy). These fixed contracts are best suited for conservative investors who are seeking predictable tax-deferred growth. Again, registered representatives must clearly disclose that an annuity is a long-term investment since significant surrender fees may be incurred if assets are not held in the contract for a minimum prescribed period. A significant disadvantage to a fixed annuity is that the fixed-dollar payments being received by the annuitant tend to not keep pace with inflation. Income that may seem sufficient today may become inadequate after 20 to 30 years of rising prices (inflation). Regulation: since fixed annuities are not securities, these contracts are typically not subject to regulation by either the SEC or FINRA. However, all annuities are governed by state insurance regulations. Lastly, there's no prospectus delivery requirement with fixed annuities and any person who sells them must have an insurance license, but need not obtain securities registration

For tax purposes, the IRS divides all annuities into two types. What are they?

For tax purposes, the IRS divides all annuities into two types—qualified and non-qualified. Qualified plans limit the type of person who may make contributions and the amount that a person may contribute. On the other hand, any person may purchase a non-qualified annuity and contribute an unlimited amount of money because the contributions are made with after-tax dollars. Any money invested on an after-tax basis will not be taxed again when it's withdrawn; only the earnings will be taxed at withdrawal. Therefore, in a non-qualified variable annuity, the investor's cost basis represents the total amount of the contributions.

What are a few Methods of Reducing Sales Charges?

Fund Families: The term fund families or fund complexes is used when defining a single investment company or mutual fund company that offers many different types of mutual funds under its brand name. The objective is to provide a large number of mutual funds that provide a broad range of investment options for investors. A customer may be able to invest a large sum of money with one fund family, receive a sales breakpoint (reduced sales charge), diversify his assets, and be allowed to switch between mutual funds. Breakpoints: Mutual fund shares must be quoted at the maximum sales charge percentage that the fund charges. However, most mutual funds offer sales breakpoints on shares that are purchased with a front-end load. Breakpoints are dollar levels at which the sales charge is reduced (the mutual fund industry's version of a volume discount). The breakpoint is set by the fund's distributer and may not be negotiated by individual broker-dealers. A fund's breakpoints must be clearly stated in its prospectus.

Describe: General Partners?

General partners have unlimited liability and are responsible for all management affairs of the partnership. GPs also assemble investors' capital, collect fees for overseeing the partnership's operations, keep the partnership books, and direct the investment of the partnership's funds. General partners have a fiduciary relationship to the limited partners in these programs. By acting as a fiduciary, a general partner has the authority to bind the partnership in its business dealings. However, a GP is restricted from engaging in the following activities: - Competing with the partnership - Testifying against the partnership - Changing the business or structure of the partnership - Commingling partnership assets with the GP's own assets or of other partnerships - Borrowing money from the partnership (GPs may lend money to the partnership at prevailing rates) - Adding or substituting another GP

Describe the different types of (Moderate Risk Category Funds) and the clients for whom they're suitable?

Growth Funds: capital appreciation is the main objective of a growth fund. The advisers of these funds invest in stocks that they believe will show above-average growth in share price. Growth stocks are more volatile than other securities and are more vulnerable to market risk; however, they also have a higher potential for long-term appreciation. These funds are most suitable for investors with long-term investment objectives and those able to tolerate fluctuations in their principal. Equity Income Funds: invest in companies that pay high dividends in relation to their market prices. These funds usually hold positions in mature companies that have less potential for capital appreciation, but are also less likely to decline in value than growth companies. Growth and Income Funds: these funds have both capital appreciation and current income as their investment objectives. Growth and income funds invest in companies that are expected to show more growth than a typical equity income stock and higher dividends than most growth stocks. However, the trade-off is that they usually offer less capital appreciation than pure growth funds, and lower dividends than income funds. Bond Funds: main objectives of bond funds are current income and preservation of capital. Since the portfolio consists of bonds only, many of these funds are susceptible to the same risks as direct investments in bonds, including credit risk, call risk, reinvestment risk, and some degree of interest-rate risk. Bond funds are grouped into subcategories according to the type of bonds that they purchase for their portfolio. Government bond funds invest in Treasury securities; mortgage-backed bond funds usually contain mortgage-backed pass-through securities that are issued by government agencies (e.g., Ginnie Mae or Fannie Mae); and municipal bond funds create portfolios that exclusively consist of municipal bonds. Actually, some municipal bond funds invest only in the municipal bonds issued by one state which provides residents of that state with triple-tax-exempt income. Corporate bond funds invest in bonds from a variety of corporate issuers and, since even highly rated corporate bonds have more credit risk than government bonds, the yields from these funds are normally higher. Some corporate bond funds buy investment-grade bonds only. On the other hand, high-yield bond funds invest in bonds that are rated below investment grade—commonly referred to as junk bonds. High-yield bond funds have the potential to pay higher returns, but also have much greater credit risk. The funds will pass through the interest payments that they receive from the bonds in their portfolios to the holders of the bond funds—either monthly, quarterly, or semiannually. One of the major differences between investing in actual bonds versus bond funds is that the actual bonds have a maturity date, while the bond funds don't. Instead, the manager of a bond fund will adjust the portfolio with new bonds. In order to receive principal in a bond fund, an investor is required to sell or redeem her shares of the fund. Only by investing in actual bonds is an investor able to have her principal returned in one lump sum when the bonds mature. Index Funds: have become increasingly popular in recent years. An index fund creates a portfolio that mirrors the composition of a particular benchmark stock or bond index, such as the S&P 500 Index. The fund attempts to produce the same return as the index; therefore, investors cannot expect the fund's returns to outperform the relevant benchmark. Nevertheless, index funds have historically outperformed a large percentage of actively managed funds. Since index funds don't require active management, they're considered to be passively managed. These funds generally have much lower fees than actively managed funds and are often used by investors who believe markets are efficient and that active management is unlikely to produce superior returns. Balanced Funds: maintain some percentage of their assets in stocks, bonds, and money-market instruments (cash equivalents). Although the percentages will vary from time to time as market conditions change, a portion of the portfolio will always be invested in each type of security. Balanced funds tend to show less volatility than common stock funds by falling less in periods of market declines and rising less in periods of market advances. Asset Allocation Funds: similar to balanced funds, these funds also invest in stocks, bonds, and money-market instruments. Fund managers determine the percentage of the fund's assets to invest in each category based on market conditions. The proper proportion of each asset class is often determined by a computer model used by the manager. Unlike balanced funds, the percentage of the portfolio that's invested in any of the three asset classes may drop to zero for a period based on the model's projections.

In relation to Variable Annuities, describe: FINRA Concerns?

Historically, some RRs have sold annuities to the wrong investors and/or recommended inappropriate exchanges within contracts. For Series 7 Exam purposes, it's possible for candidates to encounter red flag questions concerning inappropriate transfers (1035 exchanges) and/or evaluation scenarios addressing suitability concerns that are based on a client's advanced age or tax situation. A person must be prepared for questions concerning variable annuity recommendations being made to clients who may have less costly alternatives available in order to save for retirement (e.g., IRAs or qualified work-sponsored plans). Remember, although not specifically prohibited, recommending the purchase of annuity contracts within a tax-deferred account (e.g., an IRA) deserves special scrutiny since variable annuity contracts already grow tax-deferred. Additionally, annuities generally have higher expenses than similar mutual funds that could instead be placed within a retirement account. Individuals who are saving for retirement should normally exhaust all of their opportunities to contribute to employer-sponsored retirement plans (e.g., a 401(k) or IRA) before investing in a variable annuity. The benefit to employer-sponsored plans is that they're funded with deductible (pretax) contributions. Although the earnings in a non-qualified variable annuity grow on a tax-deferred basis, the contributions are made with after-tax dollars.

Describe taxation of a death beneficiary?

If an annuitant (e.g., a husband) dies during the accumulation period, the annuity's value will be included in his estate for the purpose of calculating federal estate taxes. The beneficiary (his wife) will also be required to pay ordinary income taxes on anything she receives in excess of the cost basis. The death benefit of a variable annuity skips the probate process which is a lengthy legal process that involves settling an estate according to the terms of a will.

Define & describe the following Fees & Charges: 12b-1 Charge?

In a 12b-1 arrangement, mutual funds may pay for distribution expenses by having them deducted from the portfolio's assets. These deductions are referred to as 12b-1 charges. These fees are used to pay the costs of distributing the fund's shares to the public and will cover expenses such as concessions and the costs associated with advertising and the printing of the prospectus. Before a mutual fund is able to pay its distribution expenses out of its portfolio, it must have a 12b-1 plan in place. This plan permits the board to enter into a contract with the principal underwriter that involves payments to the underwriter. The 12b-1 charges are based on an annual rate, but may be accrued and paid over shorter periods. A 12b-1 fee is an ongoing asset-based charge that's deducted from the customer's account on a quarterly basis. Typically, 12b-1 fees range between .25% and 1%, but the maximum permissible 12b1 fee is an annualized 1% of the fund's assets.

Describe Withdrawals During the Accumulation Period?

In a non-qualified contract, any capital gains and dividends earned during the accumulation period grow on a tax-deferred basis and are used to purchase more accumulation units. Withdrawals may be taken from the contract and will be taxed in accordance with how the withdrawal is made. For both initial and subsequent withdrawals, the IRS requires a last-in, first-out (LIFO) method. This means that any earnings are withdrawn first and are treated as taxable ordinary income. Ultimately, if all of the earnings have been withdrawn, the additional amounts are treated as tax-free withdrawals of after-tax contributions. **For example, a customer has made total contributions of $50,000 to a non-qualified variable annuity. The account currently has a value of $150,000 and the customer chooses to take a random withdrawal of $20,000. Using the LIFO method, the earnings come out first; therefore, the entire withdrawal is taxable as ordinary income. If an investor chooses to take a lump-sum withdrawal of the entire amount, the portion that represents earnings is taxable, while the amount equal to the investor's contribution is a non-taxable return of her cost basis. In other words, if the entire $150,000 is withdrawn, the $100,000 which represents earnings is taxable as ordinary income, while the remaining $50,000 is considered a non-taxable return of capital.

Describe the following concepts in relation to the Accumulation Period of Variable Annuities: - Sales Charges - Expenses - Management Fee - Expense Risk Charges - Administrative Expenses - Mortality Risk

In an annuity, the entire contribution is not invested since purchases are subject to various sales charges and fees. These charges and expenses are listed in the annuity's prospectus and registered representatives must explain each of these costs to their clients prior to carrying out a sale. Sales Charges: the prospectus for a variable annuity must clearly disclose all of the charges and expenses that are associated with the annuity. Today, the majority of companies impose a form of contingent deferred sales charge (also referred to as a surrender charge or withdrawal charge) which is similar to what's assessed on Class B mutual fund shares. Although FINRA rules specify a maximum sales charge of 8 1/2% for mutual fund sales, there's no statutory maximum sales charge on variable products. Instead, sales charges for variable annuities must be reasonable. Expenses: as to be expected, insurance companies that issue variable annuities have expenses. These expenses are deducted from the investment income that's generated in the separate account. Expenses include the costs of contract administration, investment management fees, and mortality risk charges. Management Fee: each of the subaccounts will usually assess an investment management fee. This is the fee that the subaccount's investment adviser receives for managing the assets. Expense Risk Charges: when an insurance company issues a variable annuity, it usually guarantees that it will not raise its costs for administering the contract beyond a certain level (referred to as the expense guarantee). The expense risk charge compensates the company if the expenses incurred for administering the annuity turn out to be more than estimated. Administrative Expenses: expenses associated with the costs of issuing and servicing variable annuity contracts including record-keeping, providing contract owners with information, and processing both their payments and requests for surrenders and loans. Mortality Risk: under this provision, an insurance company guarantees that it will make payments to the annuitant for the rest of her life. When calculating these payments, the company considers the annuitant's expected life span and promises to provide the annuitant with lifetime income even if she lives longer than expected (referred to as the mortality guarantee).

What type of investment product are Inverse ETFs and Leveraged ETFs?

Inverse and Leveraged ETFs are Short-Term Investment Products! Most inverse and leveraged ETFs reset their portfolios daily in an effort to meet their objectives. In other words, all price movements are calculated on a percentage basis for that day only. On the next day, everything will start all over. - For example, an investor pays $100 for one share of an inverse ETF based on an index with a value of 10,000. On that day, the index falls by 10% and closes at 9,000. As a result, the investors ETF share increases by 10% to $110. Rather than selling at the end of the day, the investor stays invested. On the next day, the index opens at 9,000, but rises during the day to close at 10,000, representing an increase of 11.11% (1,000 ÷ 9,000). The inverse ETF will decrease by the same percentage and, as a result, the investor's share goes down from $110 to $97.78 (11.11% of $110 = a reduction of $12.22). Although the index ended up exactly where it started, the investor's ETF is down 2.22% because it was held over multiple trading sessions. Due to this daily resetting process, an inverse or leveraged ETF's performance may not provide true tracking of the underlying index or benchmark over longer periods. For this reason, leveraged ETFs and inverse ETFs are best used for short-term trading strategies such as attempting to take advantage of intraday price swings on a given index.

What law governs investment companies?

Investment companies are organized, operated, and governed by the Investment Company Act of 1940.

Define & describe: Variable Life Insurance?

It may seem strange that life insurance may be addressed on the Series 7 Examination, but remember, if the term variable is a part of the policy's name, it's considered a security. Although the actual exam will not include a large number of insurance questions, there are some details that must be examined. Variable life insurance policies are a form of permanent insurance which requires fixed premiums, but have death benefits and cash values that may vary based on the performance of the investment options. Variable life insurance policies are regulated by state and federal securities laws and must be registered with the SEC under the Securities Act of 1933. Any offers to sell variable life insurance policies to clients must be accompanied by or preceded by a prospectus. Only an insurance company that's licensed and regulated by the state may issue a variable life insurance policy. The company that sells the policy must be a broker-dealer that's registered with the SEC and is a FINRA member. The agents who sell variable life insurance policies are required to hold both a state insurance license and either Series 6 or Series 7 securities registration. In a variable life insurance policy, the policy owner, not the insurance company, decides how the premium payments will be invested. However, an important feature of this type of insurance is that the death benefit generally may not decrease below a certain guaranteed minimum. Variable life insurance policies are NOT appropriate for all clients. A suitable client is one who has a sufficient level of sophistication and knowledge to understand the available investment options. He must be able to tolerate the fact that the policy's cash value may fluctuate greatly.

Disadvantages of Limited Partnerships?

Lack of Control Limited partners may have no managerial authority regarding the daily business of the partnership. Unlike a traditional corporation, there may be very little oversight of the management by an independent board of directors. Also, any attempt to take control of the management of the enterprise may adversely affect an investor's legal status. Illiquidity Since a limited partner's investment is normally unable to be sold quickly, it's considered an illiquid investment. In most cases, there's no actively traded public market for these investments and often limited partners are required to obtain the permission of the general partner to be allowed to sell. For these reasons, partnerships should be recommended only to clients who have sufficient liquid assets and are willing to accept a potentially long-term holding period. Tax Issues Owning a limited partnership will likely complicate a client's year-end tax filing. Since many partnerships are constructed in such a way to take advantage of certain benefits that exist in the U.S. tax code, any change in tax laws or adverse IRS rulings could negatively affect a limited partner's future returns. Possible Capital Call Unlike any other investment previously described, investors in limited partnerships may be asked to contribute additional funds subsequent to their initial investment. Failure to make the additional contribution may result in the investor forfeiting his interest in a project. Also, partnerships may request that the LPs sign a recourse loan agreement. With recourse loans, the LP is essentially co-signing on a loan arranged by the partnership. Therefore, in the event of the partnership defaulting, the LP may be wholly or partially liable for the borrowings. Alternative Minimum Tax An investment in an oil and gas limited partnership may result in excess depletion and depreciation as well as excess intangible drilling costs. Since these are considered tax preference items, an LP may ultimately be subject to the alternative minimum tax (AMT). These items, though able to be deducted when a person calculates her regular tax liability, are added back when calculating the AMT.

Differentiate between Letters of Intent & Rights of Accumulation?

Letters of Intent: Investors receive the benefit of a breakpoint without immediately depositing all of the required funds. Rights of Accumulation: The investor is able to add up all of the purchases made in the same fund complex. Once a breakpoint is reached, all future purchases are entitled to the reduced sales charge.

Describe: Limited Partners?

Limited liability is a major advantage for limited partners; however, to qualify for this advantage, the limited partners must be passive investors and avoid day-to-day management decisions. If limited partners take on an active role in the management of the programs, they may be considered general partners and have unlimited liability. Although prohibited from engaging in daily management, partnership agreements often provide certain rights to limited partners through partnership democracy provisions. Normally, LPs have the right to: - Inspect and copy the books of the partnership - Call for the dissolution of the partnership by court decree - Restrict the general partner from discharging some duties - Sue a general partner for damages and, in some cases, vote to remove the general partner - Engage in business that competes with the partnership (unlike general partners) - Receive profits and compensation as stated in the certificate

Describe the following in relation to Mutual Fund Taxation: Reinvested Dividends and Distributions?

Many investors choose to reinvest the dividends and other distributions paid by mutual funds rather than taking the payments in cash. However, investors must still report these dividends and other distributions as taxable income in the year in which they're reinvested. The cost basis of shares purchased through reinvestment is equal to the purchase price at the time of the reinvestment.

Describe the following in relation to Mutual Funds: Systematic Withdrawal Plans?

Many mutual funds offer investors the opportunity to withdraw their money systematically. If investors elect to begin a systematic withdrawal plan, they will receive regular payments from their accounts, typically on a monthly or quarterly basis. To participate in a systematic withdrawal plan, investors must have a minimum amount in their accounts (generally at least $5,000). Payments are first made from dividends and then capital gains; however, if these are not sufficient, the fund will redeem the investor's shares until the principal in the account is exhausted. Investors who choose systematic withdrawal plans have three payout options—fixed-dollar, fixed percentage, or fixed-time. With fixed-dollar payout plans, investors will receive the same amount of money with each payment. For example, a person who has $25,000 worth of shares could request that the fund send her $200 per month until all of the funds are exhausted. Investors may also request that their fund liquidate a fixed-percentage of their shares at regular intervals—for example, 1% each month or 3% each quarter (using a fixed-percentage payout plan). With this payout option, the exact dollar amount to be received by the client will vary based on the NAV of the shares at the time they're sold. The third choice for investors is to have their holdings liquidated over a fixed-time (using a fixed-time payout plan). A client who chooses this method must provide the fund with an exact ending date. Once the date is set, the fund will liquidate the client's shares in amounts that will exhaust the account by the date specified by the client.

Describe the different types of (Low Risk Category Funds) and the clients for whom they're suitable?

Money-Market Funds: invest in short-term debt (money-market) instruments that typically have maturities of less than one year. The two principal benefits for investors in moneymarket funds are liquidity and safety. Investors are able to withdraw funds at any time, often by means of receiving a check. These funds are designed to maintain a constant net asset value of $1 per share; however, this is not guaranteed. Returns vary along with short-term interest rates, while dividends are typically declared daily with payment made on a monthly basis. Money-markets funds are often used by investors as a safe haven. If an investor is uncomfortable with the current state of the stock and/or bond market, he may choose cash equivalents as his investment. This approach is most likely accomplished through a money-market investment. Not all money markets are alike; some hold only U.S. Treasury-backed instruments, others may hold commercial paper, and still others hold short-term municipal debt. Ensuring that the money market instruments selected matches the clients' risk tolerance and tax situation is extremely important for RRs. High tax bracket clients are typically placed in tax-free funds, while extremely risk-averse clients may be better served in U.S. government money-market funds.

Describe the following in relation to Mutual Funds: Dividend Reinvestment?

Most mutual funds make dividends and capital gains distributions to their shareholders on an annual basis. Once a distribution is made, the investor must then choose to either take the monies or reinvest them. Most mutual funds allow investors to reinvest dividends and other distributions at the NAV. Note; even if reinvested, the distribution is taxable but will add to the client's cost basis.

How do Variable Annuities Work?

Most variable annuities consist of two phases—the accumulation period and the annuity period.

Describe the Process of Buying and Selling Mutual Fund Shares

Mutual fund shares are purchased at their public offering price (POP) and redeemed at their intrinsic net asset value (NAV). Net Asset Value + Sales Charge = Public Offering Price The difference between these two values is the sales charge. The equation above is used to determine the purchase price of the shares of a traditional front-end load fund (Class A shares). In this case, the investor pays an up-front sales charge that's added to the NAV at the time of purchase. Fractional shares may be purchased if the amount being deposited is not sufficient to purchase an even number of whole shares. If a client intends to sell (redeem) his shares, he receives the next calculated NAV. Other share classes and pricing methods exist and will be described later in this chapter.

Describe the settlement of mutual fund transactions?

Mutual fund transactions typically settle on the same day as the purchase/ redemption. Unlike stocks, the ex-dividend date for a mutual fund is determined by the fund or its principal underwriter. Typically, a mutual fund's ex-dividend date is the business day following the record date.

Describe Net Asset Value (NAV)?

Net Asset Value = Total Net Assets / # of Outstanding Shares The NAV of a mutual fund (or any other investment company) is determined by dividing its total net assets (securities valued at their current market price, plus cash, minus total liabilities) by the total number of shares outstanding. The net asset value of a mutual fund must be computed at least once a day. A fund's prospectus discloses the cutoff time used for purchases and redemptions of shares and explains how its NAV is calculated. The net asset value is normally computed daily as of the close of trading on the NYSE.

Describe No-Load Funds?

Not all mutual funds assess sales charges. No-load funds sell open-end investment company shares to the public at simply their net asset value; there's no added sales charge. Therefore, with these funds, the net asset value and public offering price are equal. Most no-load funds are purchased directly from the fund's distributor without any compensation being paid to salespersons. To be marketed as a no load fund, a fund may not assess a front-end load, a deferred sales load, or a 12b-1 fee (described next) that exceeds .25% of the fund's average annual net assets.

In relation to Variable Annuities, describe: Principal Approval?

Once a registered representative has collected the required information on a potential deferred variable annuity customer, this complete and correct application package and the customer's non-negotiable check (payable to the issuing insurance company) must be promptly forwarded to the representative's Office of Supervisory Jurisdiction for approval. Typically, once received, the approving principal at the OSJ will review the application and determine whether the proposed transaction is suitable. The broker-dealer has up to seven business days from its receipt of the application package to make this determination. If the proposed transaction is deemed to be suitable, the paperwork and funds are transmitted to the issuing company. If not, the funds must be returned to the customer. The broker-dealer is required to maintain a copy of all checks and record the date(s) on which the funds were received. Additionally, the firm must record the date(s) the funds were either forwarded to the insurance company for purchase of the contract or returned to the customer for transactions that were not approved.

Define & Describe: Open-End Management Companies/ Mutual Funds?

Open-End Management Companies/ Mutual Funds are most popular type of investment company. The basic idea is that, for a cost, a mutual fund provides a means for investors with similar goals (e.g., long-term growth) to pool their money and invest in a portfolio of securities. As with other companies, this investment pool elects a board of directors (BOD). A mutual fund's BOD will hire an expert (i.e., an investment adviser) to perform the security selection and trading functions.

Describe Back-End Loads and Contingent Deferred Sales Charges?

Rather than assessing a sales charge at the time of purchase, some funds allow investors to buy shares at the NAV and will then assess a sales charge when the investors redeem their shares. Usually, the longer the investor owns the shares, the greater the amount the back-end load will decrease. This is referred to as a contingent deferred sales charge (CDSC). If the investor holds the shares long enough, there may be no sales charge imposed at the time of redemption.

Is it appropriate to recommend a mutual fund share class?

Recommending that a customer should buy one class of shares instead of another is acceptable provided there's a reasonable basis for believing that the recommendation is suitable. The suitability of a share class with a particular sales charge/fee mix is often based on the length of time the customer intends to hold the investment and the amount of money the customer intends to invest.

Describe the following in relation to Mutual Funds: Rights of Accumulation (ROAs)?

Rights of accumulation give investors the ability to receive cumulative quantity discounts when purchasing mutual fund shares. The reduced sales charge is based on the total investment made within a family of funds (fund complex) provided the shares are purchased in the same class. Rather than using the original purchase price, the current market value of the investment plus any additional investments is used to determine the applicable sales charge.

Define & describe the following Fees & Charges: - Service Fees - Administrative Charges - Expense Ratio

Service Fees: charges that are deducted under a 12b-1 plan and used to pay for personal services or the maintenance of shareholder accounts. Trailing commissions (trailers) are an example of a service fee. When RRs have sold fund shares to customers, they may be entitled to trailers in the years following the original sale as compensation for continuing to service the clients' accounts. Administrative Charges: charges are deducted from the net assets of an investment company and used to pay various costs that are associated with operating the fund. These charges include payments made to custodian banks and/or transfer agents. In the front of its prospectus, a mutual fund is required to disclose all of its fees using a standardized table. Expense Ratio: defined as the percentage of a fund's assets used to pay its operating costs. The ratio is calculated by dividing the fund's total expenses by the average net assets in the portfolio. The expense ratio consists of the management fee, administrative fees, and 12b-1 fees, but doesn't include sales charges. Expense Ratio = Total Expenses / Average Net Assets If a fund has total expenses of $1 million and average net assets of $100 million, its expense ratio is 1% ($1 million ÷ $100 million = .01 or 1%). Expense ratios typically range between .20% and 2% of a fund's average net assets and must be disclosed in the fund's prospectus. Ultimately, the expense ratio varies based on the fund and the share class selected by the investor.

How do we determine the offering price for a mutual fund?

Since breakpoints affect the purchase price of mutual fund shares, investors should be able to determine a mutual fund's offering price based on the sales charge percentage. The POP may be determined by using the following formula: POP = NAV / (100% - Sales Charge %) For example, if the XYZ Fund has an NAV of $10 and a person invests $100,000 into the fund, it will entitle him to a 3.25% breakpoint. What's the offering price for the investor? POP = $10.00 / (100% - 3.25%) = $10.00 / 96.75% = $10.34 In this example, the investor is able to purchase 9,671.18 shares ($100,000 ÷ 10.34).

Describe the Suitability and Compliance Issues w/ Variable Annuities?

Since variable contracts don't provide a known amount of retirement income, these contracts are best suited for investors who can deal with the fluctuation in value and payment stream and understand the risks inherent with equity investments. The hope is that the contract will continually grow at an average rate that's above the AIR and that the payments will increase to provide a hedge against inflation risk. Since deferred variable annuities contain both insurance and investment attributes, they're considered a complex investment option for clients. When a person makes a recommendation regarding the purchase of a variable annuity contract, FINRA stresses the need for suitability determination. Generally, variable annuities are not suitable for senior investors; instead, they're appropriate only for people with long-term investment goals who don't anticipate needing access to their money for at least five to seven years. While variable annuity contracts have features that are similar to mutual funds, what makes them unique is that they provide tax-deferred growth. However, many annuities impose significant charges on investors who surrender their contracts early. If an annuitant withdraws funds prior to reaching the age of 59 1/2, he's required to pay taxes on any increases in the value of his annuity plus he's subject to a 10% tax penalty. Under FINRA rules, prior to making a variable annuity recommendation, salespersons must make reasonable efforts to obtain certain client-related information including their age, annual income, financial situation and needs, investment experience, investment objectives, and investment time horizon (most contracts have CDSCs), the intended use of the deferred variable annuity, existing assets (including outside investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, and tax status. Any RR who recommends deferred variable contracts must have a reasonable basis to believe that: 1. The customer has been informed of, and understands, the various features of the contract such as surrender periods, potential surrender charges and tax penalties for redemptions prior to age 59 1/2, mortality and expense fees, investment advisory fees, and the features associated with various riders available with a given policy. 2. The customer will benefit from some feature(s) of the contract (e.g., tax-deferred growth, annuitization, death benefits, etc.). These potential benefits should be weighed against the additional costs associated with annuities compared to mutual funds or other investments. 3. The contract has subaccount choices and other features that make it suitable (as a whole) based on the client's objectives, tax situation, and age.

What are the payout options for receiving payments from an annuity?

Straight-Life Annuity A straight-life annuity is a contract in which an annuitant receives monthly payments for as long as she lives, but this method makes no provision for a designated beneficiary. Therefore, no payments are made after the annuitant's death, even if only one payment had been made before the person's death. Remember, the contract's death benefit ceases once the holder makes the decision to annuitize. This payment option carries the most risk, but also provides the annuitant with the highest payout of all of the options. Life Annuity with Period Certain A life annuity with period certain is an option that will provide monthly or other periodic payments to the annuitant for life. However, if the client dies prior to the end of the specified period, the payments will continue to be made in either a lump-sum or in installments to a designated beneficiary until the end of the period certain. **For example, an investor chooses a 15-year period certain life annuity, but dies after receiving payments for five years. The annuity company will continue to pay the named beneficiary for the remaining 10 years on the contract. However, if the investor had lived for 18 years, the annuity company's payment obligations would have continued up until his death. Since his death occurred three years after the end of the period certain, the annuity company is relieved of the obligation to make any payments to a beneficiary. Unit Refund Life Annuity Under a unit refund life annuity, periodic payments are made during the annuitant's lifetime. If the annuitant dies before an amount equal to the value of the annuity units is paid out, the remaining units will be paid to a designated beneficiary. This payment may be made either in a lump-sum or over a given period. Joint and Last Survivor Life Annuity A joint and last survivor life annuity is an option in which payments are made to two or more persons. If one person dies, the survivor continues to receive only her payments. However, upon the death of the last survivor, payments cease. ** For example, a grandfather establishes an annuity that will provide lifetime payments to both his son and grandson. A joint and last survivor life annuity is the best payout option for the grandfather's needs because it provides lifetime income to both persons.

Describe the following in relation to Mutual Fund Taxation: Cost Basis?

Subchapter M of the IRS Code provides beneficial tax treatment to regulated investment companies (RICs) that operate on a conduit or pass-through basis by distributing a substantial percentage of their income to shareholders. To qualify as an RIC, an investment company must pass through at least 90% of its net investment income (defined as dividends, plus interest, minus expenses) to shareholders. If the fund qualifies, it will only be taxed on the portion of income that it retains. Therefore, the burden of paying taxes on net investment income is primarily borne by the shareholders. Investment income, whether reinvested in the fund or received as cash, is taxable to the investor. It's important to remember that investors are taxed appropriately based on the type of security that generates the income. A mutual fund investor's cost basis represents his original investment along with all subsequent reinvestments. When calculating gains and losses on liquidated positions, investors are permitted to use their average cost basis. Average cost basis is calculated by dividing the total assets invested (including reinvested dividends) by the total number of shares owned. - For example, by making an initial investment of $20,000 in a high-yield bond fund, an investor acquires 702 shares. Over the next five years, the customer deposits another $25,000 and reinvests $14,000 of distributions all of which allows him to acquire an additional 1,240 shares. If the fund is currently valued at $27.11, what's the customer's cost basis if the average cost method is used? In this example, the investor deposited a total of $59,000 and acquired a total of 1,942 shares. The average cost is $30.38 ($59,000 ÷ 1,942). Coincidentally, the current NAV of the shares is irrelevant.

What special emphasis should a series 7 candidate have around the following investments: mutual funds, closed-end funds, unit investment trusts (UITs), and exchange-traded funds (ETFs)?

Suitability concerns & Tax issues

What are different types of investment companies?

The Act of 1940 identifies three different types of investment companies: - face-amount certificate companies - unit investment trusts - management companies

How do mutual funds advertise their services to potential investors?

The Prospectus: the fund's prospectus is the primary disclosure document for potential investors. This document includes the following information about the fund: - Investment objectives - Investment policies and restrictions - Principal risks of investing in the fund - Performance information (whether the fund made money) - The fund's managers - Operating expenses (the costs that are deducted from the fund's assets on an ongoing basis) - Sales charges (what investors pay in commissions when they buy shares in the fund) - Classes of shares the fund offers - How the fund's NAV is calculated - How investors redeem or purchase shares - Exchange privileges (whether the investor can exchange shares in one fund for shares of another fund)

Describe the Annuity Period of Variable Annuities? Annuity Units?

The annuity, benefit, or pay-out period begins if/when an annuitant elects to receive income payments from the annuity. Up to this point (during the accumulation period), a contract owner is permitted to surrender the annuity for its current value or take random withdrawals at any time. However, once the annuitant initiates the annuity period, he may not surrender the annuity or withdraw money from it. Instead, he may only receive income payments based on the value of annuity units. Annuity Units: at the point at which a contract owner decides to annuitize, the insurance company converts his accumulation units into a fixed number of annuity units. Annuity units are the accounting measurement used to determine the amount of each payment to the annuitant. At annuitization, these units become the property of the insurance company. A significant concept is that, at annuitization, the number of annuity units on which each payment is based is fixed, but the value of the units will fluctuate. The insurance company calculates the annuitant's first payment by considering the following details about the annuitant and the contract: - Age and gender - Life expectancy - Selected settlement (payout) option - Projected growth rate, referred to as the assumed interest rate (AIR)

Describe the Tax Treatment of REITs?

The benefit of qualifying as a real estate investment trust is the favorable tax treatment that's provided under the Internal Revenue Code. Unlike other corporations, there's no double taxation on the dividends that a REIT pays to its shareholders. If 90% of the ordinary income generated from the portfolio is distributed to investors, the income will only be taxed once (at the investors' levels). The REIT avoids paying taxes on distributed income in substantially the same manner as a regulated investment company. However, unlike DPPs, REITs don't pass-through operating losses. To qualify for the special tax treatment, a REIT must satisfy the following three income tests: 1. At least 95% of its gross income must be derived from dividends, interest, and rents from real property. 2. At least 75% of its gross income must be derived from real property income (e.g., rents or interest). 3. No more than 30% of its gross income may be derived from the sale or disposition of stock or securities that have been held for less than 12 months. Tax Treatment for the Investor Real estate investment trusts offer investors a stable dividend based on the income they receive, which is the reason that most investors purchase these securities. The dividends that REITs pay to their shareholders don't qualify for the reduced 20% tax rate that's given to the dividend distributions paid on common and preferred stock. Instead, the dividends received by REIT investors are taxed as ordinary income. However, based on the 2018 tax reforms, the following additional benefits are provided: - 20% of the income that's distributed by REITs is deductible (excluded from tax). - The maximum tax rate on ordinary income has been lowered to 37% (from 39.6%).

Which documents allow for creation and subsequent operation of a Limited Partnership? Describe them!

The creation and subsequent operation of the partnership is established within three documents: 1. Certificate of Limited Partnership: the purpose of the Certificate of Limited Partnership is to set forth the terms of the business relationship that's been created. Some of the information contained this document includes: - The name and purpose of the partnership - The name and address of each general and limited partner - The conditions under which the partnership will be terminated - Priority provisions in the event of partnership liquidation Typically, the procedures for forming limited partnerships are governed by state law. The certificate is a public record that must be filed at a designated state office in order for the partnership to be considered created and must be amended if substantial changes are made. 2. Agreement of Limited Partnership: the Agreement of Limited Partnership is a contract between the general and limited partners and may be contained in the Certificate of Limited Partnership or may be a separate document. The document defines the relationship between the general partner and the limited partners and typically contains the following information: - The rights and obligations of the general partner - The rights and obligations of the limited partners - Sharing arrangements for profits and losses - Withdrawal terms for limited partners - Priority provisions in the event the partnership is liquidated 3. Subscription Agreement: the subscription agreement is the document that specifies: - The amount required to be invested - To whom all checks must be made payable and who must sign the agreement - Suitability standards for the investment - A statement that attests to the investor's ability to meet the financial requirements of the investment - The parties who must sign the agreement The acceptance of a limited partner is generally recognized when the general partner signs the subscription agreement. A signed copy of this document is sent to the limited partner to serve as a confirmation of the sale of an interest in a direct participation program. If sales are executed by an underwriter (syndicator), they must be accepted by the general partner to be valid. At times, GPs may themselves act as syndicators or they may hire an investment banker to assist in the distribution. In either case, the maximum underwriting compensation for a public offering is 10% of the gross dollar amount of the securities being sold.

Describe Taxation of Life Insurance Policies?

The death benefit of a life insurance policy passes tax-free to the beneficiary. However, if the deceased person owned the policy, the death benefit is included in his estate for the purpose of calculating estate taxes. In order to avoid this problem, many tax advisers recommend that the insurance policy be placed in the name of the beneficiary or in an irrevocable life insurance trust.

Describe the following in relation to Mutual Fund Taxation: Exchange of Shares?

The exchange of shares is considered the sale of one fund's shares and the purchase of another. An exchange could result in a gain or loss and will represent a taxable event for the investor. The capital gain or loss is calculated based on the cost basis of the shares being redeemed from the first fund.

Describe the taxation issues w/ annuities?

The majority of annuities are non-qualified, which means that the contract owner invests money on an after-tax basis. However, remember, the money will still accumulate taxdeferred. In other words, an annuitant is not required to pay taxes on the increases on her investment until she begins taking distributions or withdraws funds from the account. If an annuitant withdraws money from an annuity before the age of 59 1/2, she may be subject to a penalty and also be taxed on any increase in the value of her investment. As is the case with retirement plans, these contracts don't generate capital events. If any portion of a withdrawal is subject to taxation, it's taxable at ordinary rates

Describe the liquidity for the three types of REITs?

There are three varieties of REITs. The first are those that are sold under Regulation D as private placements and not registered with the SEC. The other two are registered and are either listed or non-traded (unlisted). Most REITs are exchange-listed, traded each business day, and are reported on customer account statements at their current market value per share. On the other hand, private REITs and non-traded REITs are illiquid and are as difficult to price as hedge fund or limited partnership investments. These non-traded REITs are reported on customer account statements at their estimated market value per share.

What type of investments are annuities and variable products?

They are hybrid investments issued by insurance companies and are often offered through other financial intermediaries, such as banks and broker-dealers.

What do mutual funds, closed-end funds, unit investment trusts (UITs), and exchange-traded funds (ETFs) all have in common?

They provide investors with an efficient way to quickly buy or sell a group of underlying stocks and/or bonds.

Define & describe: Face-Amount Certificate Company?

This type of investment company is very rare today. A face-amount certificate company issues debt certificates that pay a predetermined rate of interest. Investors purchase these certificates in either periodic installments or by depositing a lump sum and then receive a fixed amount if they hold the certificates until maturity. However, investors who cash in their certificates early will receive a lesser amount—referred to as a surrender value.

Why are there different Classes of Mutual Fund Shares? Describe them!

Today, most funds offer investors the choice of multiple classes of shares, usually referred to as Class A, Class B, Class C, etc. The differences in classes are the ways in which the sales charges and distribution charges are assessed. Investors may choose between shares with front-end loads and varying 12b-1 fees (marketing fees), back-end loads with higher 12b-1 fees, or some other combination. Class A Shares: usually have front-end loads, but have small or nonexistent 12b-1 fees. In addition, investors who purchase large amounts of shares within the same fund family may be able to take advantage of reduced sales charges through the use of breakpoints or rights of accumulation (both of which are described below). The disadvantage of Class A shares is that not all of the investor's money is directed into the portfolio. For example, if an investor purchases $1,000 worth of Class A shares of a common stock fund that has a 5% sales charge, only $950 is invested in the fund. The $50 is deducted as a sales charge and benefits the selling brokers. This class of shares is most suitable for long-term investors. Although the front-end load may seem high, the continuous internal expenses of Class A shares tend to be lower than those for Class B or C shares. Class B Shares: generally have no up-front sales charges, higher 12b-1 fees are usually assessed. Investors are subject to contingent deferred sales charges (CDSC) if the shares are redeemed before a certain period. These shares are most suitable for investors who intend to redeem their shares within five to seven years, especially if the back-end load decreases every year. Once the specified number of years has passed and the back-end charge is reduced to zero, most Class B shares will convert to Class A shares. Unlike Class A shares, Class B shares don't qualify for breakpoint (sales charge) discounts. Class C Shares: assess what's referred to as a level load, which means there's an ongoing fee (typically 1.0%) for as long as the investor holds the shares. As a result, this increases the expenses of the fund and diminishes returns. These shares are most suitable for investors who will hold their shares for a short period (more than one year, but less than three years). Although there's no front-end load, a back-end load may be assessed if shares are redeemed within one year. Class C shares typically have 12b-1 fees that are higher than those on Class A shares.

Define & describe: Unit Investment Trust?

Unit investment trusts (UITs) are formed under a legal document called an indenture and have trustees rather than boards of directors. UITs invest in a fixed portfolio of income-producing securities, such as bonds or preferred stocks. UITs issue only redeemable securities that are referred to as units or shares of beneficial interest (SBIs) that are generally sold in minimum denominations of $1,000. Each unit entitles the holder to an undivided interest in the UIT's portfolio that's proportionate to the amount of money invested. Since the portfolio of a UIT generally remains static until the trust is dissolved, there's no need for an adviser to manage the trust. Since securities are not consistently being purchased or sold, UITs don't have an associated management fee. Without management, there's no management fee that applies. Because of this structure, UITs are considered to be supervised—not managed.

Define & describe: Variable Annuities? Separate Account & Subaccount?

Variable annuities are a more complex product. Rather than receiving a fixed interest rate or fixed dollar amount as offered by fixed contracts, variable annuity investors are able to choose from a menu of investment options. Contributions are invested in the insurance company's separate account with a rate of return that's not guaranteed. The investor's motivation for choosing a variable annuity is the hope that the contract will consistently grow in order to counteract the effects of inflation during retirement. The Separate Account: unique to variable products and as the name implies, the assets in an insurance company's separate account are segregated from the insurance company's general account. A separate account and its underlying subaccounts must be registered with the SEC as investment companies. All of the income and capital gains that are generated by the investments are credited to the separate account. Additionally, any capital losses that are incurred based on investment activity are charged to the separate account. However, the separate account is not affected by any other losses or gains that the insurance company incurs in its general account. Subaccounts: in a typical variable annuity, the separate account contains a number of different underlying portfolios (subaccounts) into which a contract owner may allocate his payments according to his investment objectives. Also, the contract owner may generally transfer money from one subaccount to another as his investment goals change. These transfers are not subject to tax and additional sales charges are not assessed. - Subaccount A: Growth - Subaccount B: Income - Subaccount C: Long-Term Bonds - Subaccount D: Aggressive Growth

Are there any Voting Rights when it comes to Annuities?

Variable contracts (both variable annuities and variable life insurance policies) provide contract owners with the ability to vote on certain issues that affect the separate account. These rights are similar to the voting rights that are available to mutual fund shareholders. For example, the contract owners elect the Board of Managers (similar to the board of directors for a mutual fund) that administers the separate account and approves any changes in the separate account's investment objectives or policies. The board also authorizes the selection of an independent accountant who audits the separate account.

In relation to the characteristics of Variable Life Insurance, describe: - Separate Account - Cash Value - Death Benefit - Riders

Variable life insurance policyholders make premium payments to the insurance company that issued the policy. The company first deducts various charges and expenses such as sales charges and the cost of the insurance. The company then deposits the remainder (the net premium payments) in its separate account. Separate Accounts Similar to variable annuities, these insurance policies also utilize separate accounts and their associated subaccounts. Since each of the subaccounts contains different types of securities and investment objectives, the policyholders are able to select the account(s) that best suit their needs. Cash Value Variable life policies build cash value by requiring policyholders to pay higher premiums since part of the premium pays for the death benefit coverage, while the other part goes toward the policy's cash value. Policyholders are able to use the cash value as a tax-sheltered investment (the interest and earnings on the policy are not taxable). Over time, the cash value is considered a fund from which policyholders may borrow and as a means to pay policy premiums later in life, or they may pass the funds on to their heirs. Although loans against cash value are not taxable, they are subject to interest charges. Death Benefit Most variable life insurance policies are sold with a fixed death benefit. However, the death benefit may increase depending on the performance of the subaccounts in which the policy owner invests. The death benefit may not fall below a certain minimum—the face value of the policy. On an annual basis, the insurance company will calculate and report a variable life insurance policy's death benefit. Riders A life insurance rider is an additional feature/benefit added to a life insurance policy. These could include disability income benefits, waiver of premium, guaranteed insurability, or accidental death benefits. Each rider adds to the cost of the policy above the standard cost of insurance. Riders are often selected at time of contract issuance, but some may be added after a contract has been issued.

Describe Front End Load Sales Charges?

When mutual fund shares are purchased with a front-end load (Class A shares), investors must pay the public offering price which consists of the NAV plus a sales charge. The maximum sales charge permitted under FINRA rules is 8.5%; however, breakpoints (reduced sales charges) are often available to investors who purchase a significant amount of Class A shares. The sales charge of a mutual fund share is stated as a percentage of the POP and the percentage is calculated using the following formula: Sales Charge % = (POP - NAV) / POP For example, if the XYZ fund has an NAV of $17.25 and a POP of $18.40, the sales charge percentage is 6.25% (the difference in values of $1.15 ÷ $18.40).

Describe the following in relation to Mutual Funds: Redemption Fees?

When mutual fund shares are redeemed, some funds deduct a small redemption fee from the amount paid to the investor. Redemption fees have a range of .5% to approximately 2% and are returned to the fund's portfolio. Ultimately, the fee, which is separate from any deferred charge that may apply, is designed to discourage investors from redeeming shares too quickly. Some funds waive redemption fees after the shares have been held for a specific period.

In relation to Variable Annuities, describe: Review of 1035 Exchanges?

While many persons use new funds to contribute to annuities, registered representatives may also suggest moving client assets from existing contracts. Managers must be extremely vigilant when examining the validity of a proposed transfer which is typically accomplished through a 1035 Exchange. Named after IRS Section 1035, this provision permits the exchange of annuity contracts without creating a taxable event. A principal should determine if the proposed customer transfer will result in the client incurring a surrender charge, being subject to a new surrender period, losing existing benefits (e.g., death, living, or other contractual benefits), or incurring increased fees or charges (e.g., mortality and expense fees, investment advisory fees, or charges for riders). A relatively new product is variable annuity L shares, which are referred to as short surrender securities. L shares have deferred sales charges that decline to zero in three to four years and are designed for customers who may be considering an exchange in the future. The central issue that managers must consider is the cost of the exchange compared to the benefit(s) being received by the client from the new contract. Firms and their approving principals must look for patterns of unsuitable transfers and are required to implement surveillance procedures for determining whether any of their salespersons have excessive rates of deferred variable annuity exchanges. An exchange is often viewed as inappropriate if the client has made another 1035 deferred variable annuity transfer within the previous 36 months. In order to protect against abusive transfers, many individual states and brokerage firms require the registered representatives who recommend transfers to provide disclosure and acknowledgement forms to customers. These documents often provide a comparison of the features and costs of an existing contract to a proposed replacement contract and may highlight the costs of the exchange. Generally, these acknowledgment/disclosure forms must be signed by both the firm and the client.

Name the different categories of funds?

While there are thousands of mutual funds available in today's marketplace, the key is finding the fund or funds that best meet your client's objective. Not every mutual fund is suitable for every investor. Different mutual funds will be appropriate for different clients, depending on their investment objectives and risk tolerance. 1. High Risk Category 2. Moderate Risk Category 3. Low Risk Category