Unit 8: Investment Companies
front
Principal-protected funds are typically (front/back)-end loaded, and their operating expense ratios tend to be higher than comparable funds.
common
An open-end investment company can buy preferred stock and bonds, but it cannot issue any security other than ____ stock.
asset
As an ____-based fee, 12b-1 fees are often called asset-based distribution fees. 12b-1 fees are used to cover the costs of marketing and distributing the fund to investors. These 12b-1 fees are also used to compensate registered representatives for servicing an account (trailer commissions) but shouldn't be confused with sales charges. The fee is deducted quarterly as a percentage of the fund's average total NAV.
High yield
As we have covered before, the greater the risk, the greater the reward. __ __ bond funds provide the highest yields because of their increased credit risk and are considered speculative investments.
more
Assume a NAV of $20 and a sales charge of 5%. What is the POP? POP is found by dividing the NAV by 100% minus the sales charge percentage: $20 / 0.95 = $21.05 In determining the POP when provided with the NAV, the answer has to be (less/more) than the NAV. If such a question has only one choice with a higher POP than the NAV, the correct answer should be immediately apparent.
hybrid
Balanced funds, also known as ___ funds, invest in stocks for appreciation and bonds for income. In a balanced fund, different types of securities are purchased according to a formula the manager may adjust to reflect market conditions. A balanced fund's portfolio might contain 60% stocks and 40% bonds.
a
Because the client's goal is to use the fund as part of a long-term strategy for retirement, reinvestment of distributions should be encouraged. The compounding effect of reinvestment increases the number of shares upon which distributions are based during each period. The fact that distributions are taxable— whether taken in cash or reinvested—must be disclosed to the client. Net realized long-term capital gains of the portfolio are distributed annually.
rate sec
Because withdrawal plans are not guaranteed, the registered representative must: - never promise an investor a guaranteed ____ of return, -stress to the investor that it is possible to exhaust the account by over-withdrawing, -state that during a down market it is possible that the account will be exhausted if the investor withdraws even a small amount, and -never use charts or tables unless the ___ specifically clears their use.
capitalization
Blue-chip or conservative growth funds invest in established and more recognized companies to achieve growth with less risk. Generally, these funds own shares of companies with fairly large market ____. Market cap, as it is usually referred to, is the total number of shares of common stock outstanding multiplied by the current market value per share.
fund
Charges covered by 12b-1 fees include advertising, sales literature, and prospectuses delivered to potential customers, not ___-management expenses.
B
Class A shares of an open-end investment company, (mutual fund) have a front-end sales charge, or sales load, which is computed as a percentage of the POP. That is, if the fund's POP is $10 and the NAV is $9.50, the 50-cent sales charge is 5% of the $10 offering price. In general, most of the sales load is paid to the broker-dealer making the sale as compensation. The 12b-1 fee is never referred to as a sales load because it is not related to the sale of shares.
C
Class __ shares typically have a one-year 1% CDSC, a 0.75% 12b-1 fee (discussed shortly), and a 0.25% shareholder services fee. Because these fees are relatively high and never go away, these hares are commonly referred to as having a level load. These shares are appropriate for investors who have short time horizons because they become quite expensive to own if investing for more than four years.
publicly
Closed-end investment companies are commonly known as ____ traded funds. After the stock is distributed, anyone can buy or sell shares in the secondary market, either on an exchange or OTC. Supply and demand determine the bid price (price at which an investor can sell) and the ask price (price at which an investor can buy). Closed-end fund shares usually trade at a premium or discount to the shares' NAV.
pop
Computing Sales Charge Percentage: NAV = $20 and POP = $21. What is the sales charge percentage? The sales charge percentage is calculated by finding the sales charge amount ($21 -$20) and dividing by the POP. Remember, sales charge is a percentage of the ___, not the NAV: $1 / $21 = 4.8% (when rounded)
long
Computing The Sales Charge Percentage: When the NAV and the POP are known, the sales charge percentage can be determined. If the dollar amounts for the NAV and sales charges are specified, the formula for determining the POP of mutual fund shares is NAV ($10) + sales charge dollar amount ($0.50) = POP dollar amount ($10.50). If the dollar amount of the NAV and the sales charge percentage are specified, the formula to determine POP is to divide the NAV by 100% minus the sales charge percentage. Because of the sales charge, loaded funds should be recommended for (short/long)-term investing.
compounding
Dividends and capital gains are distributed in cash. However, a shareholder may elect to reinvest distributions in additional mutual fund shares. The automatic reinvestment of distributions is similar to ___ interest. The reinvested distributions purchase additional shares, which may earn dividends or gains distributions.
income
Dividends are typically paid on a quarterly or semiannual basis, but there are ____ funds (both equity- and debt-oriented) that pay monthly dividends.
ordinary
Dividends may be identified as qualified or nonqualified. Qualified dividends are taxed at the lower long-term capital gains rate. Nonqualified dividends are taxed as ___ income.
lower
Dollar cost averaging neither guarantees profit nor protects from loss. It merely results in a (higher/lower) cost per share than the average price per share.
may not
Exchanges & Conversion Privaleges: To have the exchange take place with no-load, the following rules apply: -The purchase (may/may not) exceed the proceeds generated by the redemption of the other fund. -The redemption may not involve a refund of sales charges. -The sales personnel and dealers must receive no compensation of any kind from the reinvestment.
reported
Exchanges & Conversions: TEST TOPIC ALERT: The exam wants you to know that this is a taxable event. If there is a gain (or loss), it must be ____.
interval
Having just said investors cannot redeem their shares of a closed-end fund, we need to mention an exception. There is a breed of closed-end funds called ____ funds.
d
Holding companies are specifically excluded from the definition of investment company. Each of the others is a type defined in the Investment Company Act.
C
If the investor receives $600 a month, the dollar amount of the withdrawal is fixed. That makes this a fixed-dollar periodic withdrawal plan.
no load
In order for a fund to market itself to the public as a __ __ fund, the fund may not charge more than 0.25% of average net assets for 12b-1 fees.
margin short
Prohibited Activities Open-end investment companies are prohibited from engaging in several activities. Mutual funds may not: -purchase any security on ___; -participate on a joint basis in any trading account in securities (i.e., an investment company cannot have a joint account with someone else); -sell any security ___; or -acquire more than 3% of the outstanding voting securities of another investment company.
B
Reaching a breakpoint is the way in which investors can receive a "break" on the sales load charged when purchasing Class A shares. Purchases may be combined with spouses and dependent children, but not other family members— such as siblings—making the exception here choice B. The three ways to reach a breakpoint are: -a lump-sum purchase -using a LOI granting 13 months to reach the breakpoint -taking advantage of rights of accumulation (no time limit).
A
Shares sold with a front-end load are called Class __ shares. Front-end sales loads are the charges included in a fund's POP. The charges are added to the NAV at the time an investor buys shares. Front-end loads are the most common way of paying for the distribution services that a fund's underwriter and broker-dealers provide.
sale
TTT: Any exchange of funds is considered a ___ for tax purposes. Any gains or losses are fully reportable at the time of the exchange.
perserve
TTT: Be aware that an investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although a money market fund seeks to ____ the value of the investment at $1 per share, it is possible to lose money by investing in a money market fund.
wouldn't
TTT: FINRA warns investors that most leveraged and inverse ETFs reset daily, meaningthat they are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time—over weeks, months, or years—can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period. Therefore, in most cases, these (would/wouldn't) be suitable investments for buy-and-hold investors or those with other than a very short time horizon.
Short
TTT: Remember that an index ETF is different from an index mutual fund in the following ways: ___ selling—Index ETFs can be sold short at any time during trading hours.
A
The one thing that all open-end investment companies must do is issue common stock. That is the form of ownership. All of the other activities are prohibited.
institutional
The only other MMFs with a stable NAV are _____ money market funds, which are 99.5% government securities.
breakpoints
The schedule of quantity purchase discounts a mutual fund offers is called the fund's ____. These are available to any person. For a breakpoint qualification, person includes married couples, parents and their minor children, corporations, and certain other entities. Investment clubs or associations formed for the purpose of investing do not qualify for breakpoints.
charge
The term used for the expense of buying or selling mutual fund shares is called sales ___ or sales load. You will see us use charge and load interchangeably.
paper
The terms realized gains and unrealized gains can be confusing. Think of an unrealized gain as a ___ profit and a realized gain as actual profit made.
investor
Triple taxation? GEM Fund, Inc., owns shares of Mountain Brewing Co. To start with, Mountain Brewing is taxed on its earnings before it pays a dividend. Then, GEM Fund pays tax on the amount of the dividend it receives. Finally, the ___ pays income tax on the distribution from the fund.
interest
When ____ rates rise, the prices of bonds, and, therefore, bond funds, fall (and vice versa).
Diversification
When it comes to benefits of investment company securities in general, they all share two important characteristics: _____. By pooling assets with many others, investors have the opportunity to own an interest in a far greater number and range of securities than available to almost any individual investor.
Professional
When it comes to benefits of investment company securities in general, they all share two important characteristics: ______ management. In almost all cases, someone with expertise (we hope) is "minding the store." Even in the case of the UIT where there is no ongoing management, the initial portfolio is constructed by experts. And, although index funds and ETFsdon't require real decision making by the fund managers, they are there making sure the portfolio is updated whenever the components of the index change.
offering
When it comes to open-end investment companies (mutual funds), any person who wants to invest in the company buys shares directly from the company or its underwriters (or a broker- dealer with a selling agreement) at the public ____ price (POP). A mutual fund's POP is the NAV per share plus any applicable sales charges.
Global
_ funds have the portfolio invested around the globe, and that includes U.S. securities. Once again, using the travel example, if you were to travel around the globe, a portion of your trip would be in the United States.
Option
__ income funds invest in securities on which call options can be sold (known as covered calls). They earn premium income from writing (selling) the options. They may also earn capital gains from trading options at a profit. These funds seek to increase total return by adding income generated by the options to appreciation on the securities held in the portfolio. They generally have greater risk than other income funds.
Guarantee
__ principal. Most principal-protected funds guarantee the initial investment minus any front-end sales charge even if the stock markets fall. In many cases, the guarantee is backed by an insurance policy.
holding
It is important for you to know that the definition of investment company does not include _____ companies.
interest
Bonds pay ____; bond funds pay dividends if declared by the fund's BOD.
face amount
A ___ _____ certificate (FAC) is a contract between an investor and an issuer in which the issuer guarantees payment of a stated (or fixed) sum to the investor at some set date in the future. In return for this future payment, the investor agrees to pay the issuer a set amount of money either as a lump sum or in periodic installments.
d
A UIT is a type of investment company, which is generally unmanaged as the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the UIT terminates.
interest
A bond fund does not pay interest to investors. Investors buy common stock of the bond fund and, therefore, will receive a dividend if declared. Even though it is a dividend, because the source is ___ it is taxed as that. That is why you can receive a dividend from a municipal bond fund that is tax-free.
A
A closed-end investment company (closed-end fund, or CEF) is a type of investment company whose shares trade in the secondary market. It is critical to remember for the exam that the price of a closed-end company is based on supply and demand and, therefore, can sell at, above, or below the fund's NAV.
dollar
A customer may request the periodic withdrawal of a fixed-____ amount. Thus, the fund liquidates enough shares each period to send that sum. The amount of money liquidated may be more or less than the account earnings during the period.
income
A growth and ___ fund (combination fund) may attempt to combine the objectives of growth and current income by diversifying its stock portfolio among companies showing long-term growth potential and companies paying high dividends. Often, both value and growth management styles are utilized.
family
A mutual fund company frequently offers more than one fund and refers to these multiple offerings as its __of funds. An investor seeking a reduced sales charge may be allowed to combine separate investments in two or more funds within the same family to reach a breakpoint.
intent
A person who plans to invest more money with the same mutual fund company may immediately decrease his overall sales charges by signing a letter of ___(LOI). In the LOI, the investor informs the investment company that he intends to invest the additional funds necessary to reach the breakpoint within 13 months.
b
A unique characteristic of mutual funds is that they are capitalized by a continuous offering of new shares. Whenever an investor adds to her portfolio, she is buying new shares of common stock issued by that fund. UITs issue units, not shares, in a one-time offering.
units
A unit investment trust issues only redeemable securities, known as ___ or shares of beneficial interest, each of which represents an undivided interest in a portfolio of specified securities. Once the specified total is raised, the trustees use the investor's money to purchase securities designed to meet the UIT's stated objective.
performance
Aggressive growth funds are sometimes called ___ funds. These funds are willing to take greater risk to maximize capital appreciation. Some of these funds invest in newer companies with relatively small capitalization (less than $2 billion capitalization) and are called small-cap funds.
dividing
All mutual funds have expenses. It is important that you understand these expenses are not considered a cost of purchasing the fund. A fund's expense ratio expresses the management fees and operating expenses as a percentage of the fund's net assets. All mutual funds, load and no-load, have expense ratios. The expense ratio is calculated by ________ the annual operating expenses by the average dollar value of the fund's assets under management.
passive
Although, as stated, most ETFs are ___ in that they are based on some index, in recent years, there has been a growth in actively managed ETFs where, instead of attempting to mirror an index, the managers select individual assets based upon expected performance. Therefore, there are ETFs that purchase equities only, fixed income securities only, or a combination. Some even purchase non-securities assets such as commodities.
increases
An expense ratio of 1.72% means that the fund spends $1.72 per year for every $100 of invested assets. Typically, more aggressive funds have higher expense ratios. An aggressive growth fund's expense ratio is usually higher than that of a AAA bond fund because more trading occurs in the growth fund's portfolio... ...That (increases/decreases) the commission expense.. and, because the portfolio manager is generally making more decisions, the management fee tends to be higher.
equity
An income fund primarily composed of stock, also known as an ___ income fund, stresses current income over growth. The fund's objective may be accomplished by investing in the stocks of companies with long histories of dividend payments, such as utility company stocks, blue-chip stocks, and preferred stocks. These are managed for income, not growth.
6.5
An investor deposits $5,000 (paying a 6.5% sales charge) in a mutual fund but does not sign an LOI. The $5,000 grows to $10,000 over time and the investor decides to invest another $15,000. If rights of accumulation exist, the new $15,000 pays a 5.5% sales charge, which is based on the new money plus the accumulated value in the account ($15,000 $10,000 $25,000). If rights of accumulation do not exist, the sales charge would have been ___%.
redeemable
An open-end investment company sells ____ securities. When investors liquidate their shares, the company redeems them at their NAV. For each share an investor redeems, the company sends the investor money for the investor's proportionate share of the company's net assets. Therefore, a mutual fund's capital shrinks when investors redeem shares.
mutual fund
An open-end investment company, or __ __, does not specify the exact number of shares it intends to issue. It registers an open offering with the SEC. The open-end investment company can raise an unlimited amount of investment capital by continuously issuing new shares. As we will cover in Unit 20, because the shares are always a new issue, it is requiredto deliver a prospectus prior to or concurrent with the sale. As a consequence, investors in mutual funds are always purchasing a new issue.
outside
Another way of stating that no more than 60% of the directors may be interested persons is to say that at least 40% must be noninterested, that is, "____" directors. These are individuals who have no connection to the fund other than a position on the board (and maybe owning some shares of the fund as would any investor).Typically outside directors are academics or prominent community members.
exchange
Both leveraged and inverse index funds (leveraged or not) can be traded on an _____. When they are, they are known as ETFs. If the shares are exchange-traded, they are priced by supply and demand, can be purchased on margin, and bought and sold throughout the trading day, like all exchange-traded products. For those that are not exchange-traded (e.g., inverse mutual funds), they would be priced, purchased, and redeemed like all investment company shares. Neither of these fund types carry any guarantee that they will achieve the stated goal or objective.
risk
Even with the benefits offered by diversification and professional management, market prices do fluctuate. Equity funds have market ___. As will be covered in detail in Unit 14, a risk with equity conditions is that economic conditions beyond the control of the individual company can cause stock prices to fall.
25
FINRA does permit an additional 0.25% charge for shareholder services (__ basis points), but that is treated separate from the 12b-1 fee for marketing and promotion.
breakpoint
FINRA prohibits registered representatives from making or seeking higher commissions by selling investment company shares in a dollar amount just below the point at which the sales charge is reduced. This violation is known as a ___ sale, and is considered contrary to just and equitable principles of trade. It is the responsibility of all parties concerned, particularly the principal, to prevent deceptive practices. remember, Breakpoints offer a significant advantage to mutual fund purchasers; however, breakpoint sales are prohibited.
gains
Hold a mixture of bonds and stocks. Most principal-protected funds invest a portion of the fund in zero coupon bonds and other debt securities, and a portion in stocks and other equity investments during the guarantee period. To ensure the fund can support the guarantee, many of these funds may be almost entirely invested in zero coupon bonds or other debt securities when interest rates are low and equity markets are volatile. Because this allocation provides less exposure to the markets, it may eliminate or greatly reduce any potential _____ the fund can achieve from subsequent gains in the stock market. It also may increase the risk to the fund of rising interest rates, which generally cause bond prices to fall.
capital gain
If you purchased 100 shares of ABC stock at $100 per share and the market value of ABC is now $150 per share, you would experience an unrealized gain of $5,000, ($15,000 $10,000). We call this a paper profit because the gain is only on paper. You would have no taxes to pay on this paper profit. If you sold the shares, the $5,000 would be taxable to you as a ____ ____. The gain resulting from a sale is known as a realized gain. Unrealized profits are not taxable; realized profits are taxable as capital gains.
c
Income funds have the goal of producing income; that is why they are named as such. This is a case where you "don't look a gift horse in the mouth."
interest
Income-oriented funds, especially bond funds, may be subject to ___ rate risk. As we have covered several times, when interest rates rise, bond prices fall. Unlike an individual bond that ultimately repays principal at maturity, a bond fund doesn't have a maturity date. The only mutual fund that generally does not fluctuate in price is the money market fund, but there is a trade-off in lack of growth and low income. Not only that, but the income of a money market fund will vary, unlike that of a bank CD, which is fixed and insured by the FDIC.
c
Investors who sign a LOI stating they will invest a specified amountover a 13-month period are eligible for a reduced sales load if they invest enough to reach the breakpoint within that time. Breakpoints entitle investors to reduced sales charges.
qualified nonqualified
Just as with dividend distributions, whether capital gains are taken in cash or reinvested, they are currently taxable to the shareholder. Dividends will be reported as _____(taxed at a lower rate) or nonqualified (taxed as ordinary income). Any short-term capital gain is distributed as a ______ dividend. It is the shareholder's responsibility to report all dividends and long-term capital gains distributions to the IRS and state tax agency.
year
Long-term capital gain distributions may be made no more than once every ___. A short-term capital gain is identified and distributed, but taxed as a dividend distribution, and taxed at ordinary income tax rates.
Sector
Many funds attempt to specialize in particular economic sectors or geographic areas. These funds must have a minimum of 25% of their assets invested in their specialties. ___ funds offer high appreciation potential, but may also pose higher risks to the investor as a result of the concentration of investments. These funds are speculative in nature. They include gold, technology, pharmaceutical, and biotechnology funds, but can also be geographic, such as investing in companies located in the Pacific Basin or Silicon Valley.
exchange
Many investment companies offer the _____ or conversion privilege within their families of funds. Exchange privileges allow an investor to convert an investment in one fund for an equal investment in another fund in the same family at NAV without incurring an additional sales charge. For example, those who started investing when in their 30s or 40s by placing their money into an aggressive growth fund might consider moving into something more conservative when they reached their 50s. Once they hit their 60s and 70s, they would want to have a greater percentage of their money in income funds. By staying in the same family of funds and using the exchange or conversion privilege, all of these changes could be made free of sales loads.
exchange
Many sponsors offer ____ or conversion privileges within their families of funds. A mutual fund family, (sometimes referred to as a fund complex), is when a single sponsor or distributor offers more than one fund. In many cases, there are more than a dozen funds with different objectives in the same fund complex. There are even a few with more than 100 funds.
mutual
Money market ____ funds (MMF) for retail investors are designed to have a stable NAV of $1 per share. They are not guaranteed, nor are they protected by FDIC insurance. It is rare, but it is possible to lose money in a money market mutual fund as a retail investor.
c
Money market funds generally come with a check-writing privilege, offering investors the opportunity to convert the asset to cash at once. Although all mutual funds are readily redeemable, the fund has seven days to redeem. One must request the cash value from the insurance company and, in many cases, it can take 30 days or longer.
open
Most ETFs are (open/closed)-end companies, but they cannot be referred to as mutual funds because shares are not redeemable by the issuer. Furthermore, as a result of all trading taking place in the secondary markets, delivery of a prospectus is not required. Because ETFs trade on exchanges in the same manner as CEFs, there is a tendency to equate them. As mentioned earlier, ETFs are not actively managed. CEFs are management companies with full time, active portfolio managers.
closed
Most _____-end companies, including BDCs, qualify as RICs for the tax benefit to investors.
d
Municipal bonds are considered second only to U.S. government securities in terms of safety. Furthermore, whenever you see a question about an investor in a high tax bracket, always look for the answer choice with municipal bonds; the tax-free income is the key. On the other hand, when you see growth, dividends will probably not be part of the equation.
voluntary
Mutual funds have a number of arrangements to implement an investment program. A ___ accumulation plan allows a customer to deposit regular periodic investments ona voluntary basis (minimum amounts found in the prospectus). The plan is designed to help the customer form regular investment habits while still offering some flexibility. This is an easy way to take advantage of dollar cost averaging.
are not
Net Investment Income: Test Topic Alert: You may see a question on the exam that asks for this calculation and gives a list of items to exclude or include in the calculation. Remember D + I - E, and it will be easy to remember which items to include. Note that capital gains (are/are not) a part of NII.
investment
Net _____ income (NII) includes gross investment income—dividend and interest income from securities held in the portfolio—minus operating expenses. Advertising and sales expenses are not included in a fund's operating expenses when calculating NII, but management fees, custodian bank charges, and legal and accounting fees are included. NII = dividends + interest - expenses of the fund
net
Net redemptions is a risk unique to open-end investment companies (mutual funds). Sometimes, particularly during declining markets, there is an excess of shareholder redemptions over new share purchases. This is known as ___ redemptions. When that occurs, the portfolio manager is put in the difficult position of having to decide which assets to liquidate when prices are falling. A fund suffering with net redemptions is probably not going to deliver your clients the performance they are seeking.
target date
One increasingly popular investment option is a __ __ fund, sometimes called a life- cycle fund. According to a report by a large retirement plan provider, target-date funds are offered by nearly 90% of employer-sponsored defined contribution plans, such as 401(k) plans.
priced
One of the most significant differences between open-end and CEFs is the way in which they are ____. Although both types of funds compute the NAV per share, it is only the open-end company whose price is solely dependent upon that calculation. The exam will have several questions on how and why each pricing method is used.
c
One thing that neither of these products can claim is performance better than the underlying index. Think about it—the index has no management fees.Even though the management fees on index funds are very low and those on ETFs are generally lower than that, there are still expenses making it unlikely that their performance can beat that of the index. The fact that an investor can trade the ETF during the day instead of accepting whatever the next computed price is, can be a benefit for those who are trying to time the market. And, for those who wish to add the leverage of margin trading (explained more fully in Unit 16), that can only be done with ETFs, not index mutual funds.
net asset value
Open-end and closed-end investment companies have far more similarities than differences. One of these is the term, __ ___ ___ per share, generally shown as NAV. This value is the result of the fund valuing all of its assets (the largest of which is the portfolio), subtracting its liabilities, and then dividing that by the number of shares outstanding. This NAV per share computation is critical to the purchase and sale of open-end companies, and, as we'll see, has little relationship to the buying and selling price of CEFs.
b
Regulated companies under Subchapter M of the IRS Code are allowed to pass-through income to beneficial owners without a tax at the fund level on the distributed income (known as conduit or flow-through of income and taxation).
Intraday
TTT: Remember that an index ETF is different from an index mutual fund in the following ways: ____ trading—Investors do not have to wait until the end of a trading day to purchase or sell shares. ETF shares trade and are priced continuously throughout the day, making it easier for investors to react to market changes.
Margin
TTT: Remember that an index ETF is different from an index mutual fund in the following ways: _____ eligibility—Index ETF shares can be purchased on margin, subject to the same terms that apply to common stock.
13 don't
Test Topic Alert: -Letters of intent are good for a maximum of __ months and may be backdated 90 days. -If the LOI is not completed, the sales charge amount that applies is based on the total amount invested. -Share appreciation and income paid by the fund (do/don't) count toward completion of the letter.
lower
Test Topic Alert: It is important to understand the concept of dollar cost averaging. It involves investing a fixed amount of money every period, regardless of market price fluctuation. If the market price of shares is up, fewer shares are purchased; if the market price of shares is down, more shares are purchased. Over time, if the market fluctuates, dollar cost averaging will achieve a (higher/lower) average cost per share than average price per share. A frequent question on the exam relates a participant in a 401(k) plan regularly investing in an index mutual fund as an example of dollar cost averaging.
relevance
Test Topic Alert: We said earlier that CEFs also compute NAV; however, because their price is determined by supply and demand and, as a consequence, may be more than, the same as, or less than the NAV, it does not have the ___ that it does with open- end funds. Therefore, instead of daily computation, it is generally only done once per week.
dependents
Test Topic Alert: You can expect a question on who is eligible for breakpoints. Married couples, parents with minor children, and corporations are eligible. Parents combined with adult children (even if they are legally considered ____) and investment clubs are not eligible.
quarterly
The 12b-1 fee is expressed as an annual amount but is charged and reviewed ______ .
c
The Investment Company Act of 1940 requires that all advisory contracts contain a provision that the contract may be terminated upon no more than 60 days' notice in writing. There is no requirement that the custodian bank have FDIC insurance. Shareholders must receive financial reports at least semiannually. The minimum capitalization of an investment company offering shares to the public is $100,000.
more
The average price per purchase is the sum of the prices paid divided by the number of investments: $114 / 4 =$28.50. The average cost per share is total amount spent divided by the number of shares purchased: $2,400 / 90 = $26.67. This lower cost is because of automatically purchasing (less/more) shares when the price was low and fewer shares when the price was high. In this case, the average cost is $1.83 per share less than the average price.
D
The conversion privilege is frequently referred to as the exchange privilege. You need to know that, unlike conversion of a bond or preferred stock to common stock, which is not a taxable event, converting from one fund to another is considered a sale and new purchase. If the old shares have appreciated, there would be a taxable capital gain.
b
The distinguishing feature of Class _ shares is that they impose a contingent deferred sales charge (CDSC), also called a back-end load. The CDSC normally declines and eventually is eliminated over time. Once the CDSC is eliminated, almost all Class B shares convert into Class A shares. When they convert, they will be charged the same (lower) asset-based 12b-1 fee as the Class A shares. These shares do not impose a sales charge at the time of purchase, so unlike Class A share purchases, 100 cents of the invested dollar are invested.
long
The exam is fond of asking a question like this: An investor purchases shares of a mutual fund. Three months later, the fund has a long-term capital gains distribution. This would be taxed to the investor as ____? The answer is ____-term capital gain. Why? It makes no difference how long the investor held the fund shares; this is a distribution of the fund's long-term gains being passed through to the investor. However, when the investor sells his shares, then the holding period of those shares is important for determining long-term or short-term status.
d
The factors used to determine the tax due on a capital gains distribution are the length of time the fund held the securities before selling them, which would identify the gain as long- or short-term, and the investor's tax bracket, which would determine the actual percentage of tax due. In virtually every case on the exam, the distribution will be of the fund's long-term capital gains.
averaging lower
The low cost of entry makes dollar cost averaging available for even the smallest of investors. One method of purchasing mutual fund shares is called dollar cost ____, where a person invests identical amounts at regular intervals. This form of investing allows the individual to purchase more shares when prices are low, and fewer shares when prices are high. In a fluctuating market and over time, the average cost per share is (higher/lower) than the average price of the shares.
.75
The maximum allowable 12b-1 charge under FINRA rules is ___% (75 basis points).
managment
The most familiar type of investment company is the ____ investment company, which actively manages a securities portfolio to achieve a stated investment objective. A management investment company is either closed-end or open-end. Mutual funds are open- end investment companies. Initially, both closed-end and open-end companies sell shares to the public; the difference between them lies in the way they raise capital and how investors buy and sell their shares—in the primary or secondary market.
government
The word agencies is a generic term used to describe two types of bonds: bonds issued or guaranteed by U.S. federal government agencies, and bonds issued by ____-sponsored enterprises (GSEs)—corporations created by Congress to foster a public purpose, such as affordable housing.
commissions
There are now some U.S.-listed ETFs that are available for commission-free trading on certain select platforms (these are typically proprietary funds). These products can be bought and sold without traditional brokerage ____ for investors with certain accounts and subject to certain restrictions. For exam purposes, these are the exceptions rather than the rule.
expense
There is also ___ risk. Frequently, a fund may temporarily reduce a fee. It will notify investors when that reduction has ended, but many investors don't take the time to read the fine print.
conduit
Triple taxation of investment income can be avoided if the mutual fund qualifies under Subchapter M of the IRC. If a mutual fund acts as a ____ (pipeline) for the distribution of NII, the fund may qualify as a regulated investment company (RIC). This means it is subject to tax only on the amount of NII the fund retains. The portion of the NII distributed to shareholders escapes taxation at the mutual fund level.
security
U.S. government funds purchase securities issued by the U.S. Treasury or an agency of the U.S. government, such as Ginnie Mae. Investors in these funds seek current income and maximum safety. Agency ___ funds are not considered quite as safe from default risk as U.S. government funds; therefore, the yields on agency security funds will be higher than U.S. government fund yields.
adviser units investment
UITs are not actively managed; there is no board of directors (BOD) or investment ____. UIT shares (______) must be redeemed by the trust. UITs are _____ companies as defined under the Investment Company Act.
percentage
Under a fixed-___ or fixed-share withdrawal plan, either a fixed number of shares or a fixed percentage of the account is liquidated each period.
time
Under a fixed-____ withdrawal plan, customers liquidate their holdings over a fixed period.
C
You must remember that the 5% and 10% limitations only apply to 75% of the fund's portfolio. The other 25%—in this case, $250 million—can be invested wherever the fund's management desires. Within the diversified 75%, the fund can own $50 million of a single issuer's stock (5% of the $1 billion total). Then, the other 25% can purchase $250 million, giving it a total of $300 million in one stock. That $300 million could buy 100% of the voting shares of many publicly traded companies. Remember, that 10% limit only applies to the diversified 75%.
Bond
_ funds have income as their main investment objective. Some funds invest solelyin investment-grade corporate bonds. Others, seeking enhanced safety, invest only in government issues. Still others seek to maximize current income by investing in lower-rated (junk) bonds for higher yields.
Large
_-cap funds have market capitalization of greater than $10 billion. The lower the market cap, the greater the volatility.
Blend core
_/___ funds are stock funds with a portfolio comprising a number of different classes of stock. Such a fund might include both blue-chip stocks and high-risk/high-potential-return growth stocks. Both growth and value management styles are used. The purpose is to allow investors to diversify their investment via management and securities in a single fund.
investment
__ An ___company is a corporation or a trust through which investors may acquire an interest in large, diversified portfolios of securities by pooling their funds with other investors' funds and buying shares or units of the fund. People often invest in investment companies because they believe a professional money manager should be able to outperform the average investor in the market. Investment companies, especially mutual funds, offer many services that benefit investors. One of the challenges for any registered representative is matching the right fund to the customer's objectives.
lock up
__ __ period. If you sell any shares in the fund before the end of the guarantee period—a period of anywhere from 5 to 10 years—you lose the guarantee on those shares and could lose money if the share price has fallen since your initial investment.
Asset
__ allocation funds split investments between stocks for growth, bonds for income,and money market instruments or cash for stability. Fund advisers switch the percentage of holdings in each asset category according to the performance (or expected performance) of that group. These funds can also hold hard assets, such as precious metals like gold and silver, and real estate.
Value
__ funds (and, therefore, value managers) focus on companies whose stocks are currently undervalued (earnings potential is not reflected in the stock price). These undervalued companies are expected to perform better than the reports indicate, thus providing an opportunity to profit. Value stocks typically have dividend yields higher than growth stocks. Funds managed for value are considered more conservative than funds managed for growth.
Global
__ funds and worldwide funds invest in the securities of both the United States and foreign countries. The risks involved in a fund concentrating in foreign securities are somewhat different than those for a domestic fund. When a portfolio has a large percentage of foreign securities, currency risk and political risk become paramount. These risks are elevated when investing in frontier funds, which invest in pre-emerging economies, because accounting and regulatory schemes are often much less rigorous than what we are used to here in the United States.
International
__ funds have their entire portfolio invested in securities issued outside of the United States. The way to remember that is if you will be traveling internationally, you'll be outside the United States.
International
__ funds invest only in the securities of foreign companies. These companies have their headquarters and principal business activities outside the United States. Long-term capital appreciation is their primary objective, although some funds also seek current income.
Special
__ situation funds buy securities of companies that may benefit from a change within the companies or in the economy. Takeover candidates and turnaround situations are common investments. These funds are also speculative (high risk).
Mid
__-cap funds are somewhat less aggressive and have in their portfolios shares of companies with a market capitalization of between $2 billion and $10 billion.
Principal
__-protected mutual funds offer investors a guarantee of principal, adjusted for fund dividends and distributions, on a set future date (maturity) while providing opportunities for higher returns through investment in higher risk and higher expected return asset classes such as equities. The basic guarantee is that the investor's return will never be less than the original investment, less any sales load.
money market
___ ____ funds are no-load, open-end investment companies (mutual funds) that serve as temporary holding accounts for investors' money. As the name implies, the portfolio ofa money market fund consists of money market securities. Money market mutual funds are most suitable for investors whose financial goals require liquidity above all.
Index
___ funds invest in securities that mirror a market index, such as the S&P 500. An index fund buys and sells securities in a manner that mirrors the composition of the selected index.
Growth
___ funds invest in stocks of companies whose businesses are growing rapidly. Growth companies tend to reinvest all or most of their profits for research and development rather than pay dividends. Growth funds are focused on generating capital gains rather than income.
open
____ -end Investment Companies: Capitalization: unlimited; continuous offering of shares issues: common stock only; no debt shares: full or fractional offering and trading: sold and redeemed by fund only. continuous primary offering. must redeem shares. pricing: nav + sales charge. selling price determined by formula in the prospectus; the price can never be below the NAV.
Corporate
____ bond funds, in general, have higher credit risk than various government issues but can still be classified as investment-grade (safer) or noninvestment-grade (riskier) portfolios.
closed
____-end investment companies: capitalization: fixed; single offering of shares issues: may issue: common stock, preferred stock, debt securities Shares: Full only Offering and trading: initiative; primary offering. Secondary trading ORC or on an exchange. Does not redeem shares. Pricing: curent market value + commission. Price is deterred by supply&demand so it can be above, below, or same as the NAV.
unit
_____ Investment Trusts: The next of the entities meeting the definition of an investment company under the Investment Company Act is the UITs. These investment trusts are unmanaged investment companies organized under trust indentures. UITs do not
closed
_____-end investment companies trade in the secondary market (exchange or OTC). That makes their price based upon supply and demand for their shares. As a result, their buying and selling price does not have a direct relationship to the NAV of the shares. Put another way, the market price of a closed-end fund is independent of the fund's NAV.
10
a diversified investment company meets this 75-5-10 test: -75% total assets in cash + securities issued by unrelated companies -5% limit for each issuer -no more than __% of the outstanding voting securities of any one issuer is owned (by the 75%)