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Series 7- Passed with 83% > Chapter 10: Investment Company Products 17-20 questions > Flashcards

Chapter 10: Investment Company Products 17-20 questions Flashcards

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Series 7 Top-off Exam flashcards
1
Q

What is an investment Company?

A

An Invest company pools investors money and invests in securities on their behalf

Tries to invest more efficiently than the single individual

Sell shares for capital and must abide by same registration and prospectus requirements imposed by Securities act of 1933

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2
Q

Investment Companies act of 1940

A

Provides for SEC regulation

Classifies investment companies into 3 broad types:

  1. Face amount certificate companies (FACs)
  2. Unit investment trusts UITs
  3. Management investment companies
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3
Q

Face Amount Certificate Company

A

Contract in which the issuer guarantees a future payment in return for a lump sum or series of payments

Very few operate today due to tax law changes

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4
Q

Unit investment Trust

A

Does not have a board of directors, employ investment advisors or actively manage a portfolio

Functions as a holding company for investors

Purchase other invesmtent company shares or gov and municipal bonds

Then issue shares of beneficial interest in the underlying portfolio

Any security liquidated is distributed

Can be fixed (purchase portfolio of bonds that will liquidate) or nonfixed (shares of a mutual fund)

Customers can ask to liquidate a position

Not actively managed, not traded in secondary, must be redeemed by trust

Not traded in response to market conditions

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5
Q

Management Investment Companies

A

Actively managed to achieve a specified investment objective

Either closed end or open end

Both sell securities at beginning, difference lies in type of securities and where investors buy and sell shares

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6
Q

Closed end Investment company

A

Conducts a common stock offering to issue shares

Funds capitalization is fixed unless public offering is made later

Can also issue bonds and preferred stock

Shares are not redeemed by issuer rather a customer liquidates a position by selling their securities in the OTC or on exchange

Prospectus only needed during IPO

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7
Q

Open end investment company (Mutual Fund)

A

Registers an open offering with the SEC and does not specify how many shares it will sell

Fund sells underlying holding when an investor wants to sell

Mutual fund shares are sold at the Net Asset Value plus a sales charge which is the POP

Has a board of directors and management

Ex date is set by BOD instead of an exchange

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8
Q

Diversified investment company

A

Under the Investment Company Act of 1940, an investment company qualifies as diversified if it passes the 75-5-10 test

75% of total assets- invested in securities outside of mutual fund or affiliates. Cash on hand and money market is counted

Within 75% no more than 5% invested in one issuer

With 75%, fund does not own more than 10% of outstanding voting securities of any one issuer

Other 25% okay to do, so a company could own 30% of one issuer if other part is diverse

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9
Q

Nondiversified Investment Co.

A

Fails to meet 75-5-10 rule

Not necessarily a fund that invests only in a certain industry

Specialized or Sector funds are often diverse in a specific industry or geographic area

Both open and closed can be diversified or non diversified

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10
Q

Exchange Traded Funds

A

Legally classified as a UIT or Open end fund but differ from tradition

Issue shares in large blocks (50,000 shares) known as creation units, usually purchased by large institutional traders and then broken apart

Positions can be sold in secondary market or in creation units back to issuer. Usually will be given underlying securities instead of cash if sold in creation unit

Cannot be called mutual fund shares, though they will be compared to

Trade throughout day

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11
Q

Mutual Fund vs ETF

A

Advantages of an ETF over a mutual fund:
1. ETFs are priced throughout the day and can be traded during the day. Mutual funds are usually priced at end of day.

  1. Margin- ETFs can be bought and sold on margin. Mutual funds cannot.
  2. Operating costs-Lower than mutual funds usually
  3. Do not usually distribute capital gains, so they are more tax efficient

Disadvantages-
1. Commisionable transaction to buy an ETF unlike a mutual fund (cannot charge commission on Prospectus sold shares)

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12
Q

An investment company must register with the SEC if:

A
  1. If it is in the business of investing in, reinvesting in, owning, trading or holding securities
  2. Has 40% or more invested in securities (government and majority owned subsidiaries not included)
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13
Q

Registration Requirements for investment companies

A

May not issue securities unless it has:

  1. Private capitalization (seed money) of 100k
  2. 100 investors and
  3. Clearly defined investment objective

May still register if it can meet these requirements in 90 days

Investment objective may only be changed by majority vote later

Open Ended companies also are required to only have one share class and a minimum asset to debt ratio of 300%

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14
Q

Require material for an investment company to register with SEC

A

Registration Statement and follow public offering procedure

Must identify:

  1. Type of investment company
  2. Plans to raise money by borrowing
  3. Intention to concentrate Investments in a single industry (if it will do that)
  4. Plans for investing in real estate or commodities
  5. Conditions where an investment strategy change would take place
  6. Name and address of affiliated people
  7. Business experience of each officer and director in past 5 years
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15
Q

Investment Company registration Statement

A

2 parts
Part 1- Prospectus of the company, also known as N1-A Prospectus or summary Prospectus

Part 2- Information not required to be distributed but must be made publicly available. Also called: statement of additional information (SAI). Will usually contain consolidated financial statements. Available upon request to Investor.

Still includes disclaimer from SEC saying SEC does not in anyway approve the securities

Open End Must also include an additional disclosure (summary section) of:

  1. Investment objectives
  2. Costs of investing
  3. Principal invest strategies, risk and performance
  4. Investment advisers and portfolio managers
  5. Brief purchase sales and tax info
  6. Financial intermediary compensation
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16
Q

Open End investment company share offerings

A

Considered to be one continuous public offering

Prospectus must be delivered each time and all info must be updated within 16 months

Reason why regulation t bans buying on margin

Mutual fund shares however can be used as collateral as long as they are fully paid for 30 days

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17
Q

Mutual fund must disclose the following investment strategies and meet specific financial requirements

A

Purchasing securities on margin
Selling securities short
Participating in joint investment accounts

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18
Q

The following issues must be voted on by shareholders:

A 
Change in company bylaws
Change in borrowing by open End company's 
Issuing or underwriting securities
Purchasing or underwriting real estate
Making loans
Changing sub classification 
Changing load policy
Changing nature of business
Changing investment policy
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19
Q

Investment company Board of Directors

A

Consists of a CEO, officers and a board

The board:

  • Defines the type of funds to offer
  • Defines the funds objective
  • Approves and hires the transfer agent, custodian and investment adviser

Majority of Directors must be non interested or independent

Must serve terms no shorter than a year and no longer than 5

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20
Q

Investment company: Investment Adviser

A

Investment company’s BOD contracts with an outside IA or Portfolio Manager to:

  • invest cash and securities in the portfolio
  • Implement an investment strategy
  • Identify tax status of distributions
  • Manage the portfolios day to day trading

Company may not contract with the IA if they have committed a securities related felony

Investment Company may not borrow funds or transfer responsibility to anyone else

IA must be registered under the Investment Advisers Act of 1940

IA contract is for a maximum 2 years but subject to annual approval and receives the managers fee

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21
Q

Investment Company: Custodian

A

Act of 1940 requires that securities must be put in custody of a bank or stock exchange member broker dealer

Handles clerical function

Can put Securities in a system for easy bookkeeping

Custodian must:

  1. Keep the investment company’s assets physically segregated
  2. Restrict Access to certain officers and employees of invest company

Receives a fee for service

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22
Q

Investment Company: Transfer Agent

A
  • Issues, redeems and cancels fund shares
  • Handles name changes for funds
  • Sends customer confirmations and fund distributions
  • Records outstanding shares so distributions are made properly

Can be the custodian, fee is paid

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23
Q

Investment Company: Underwriter

A

Sometimes called the sponsor or distributor

Receives fee for selling and marketing the fund shares to public

Sells only to help issuer fill custom orders

May not keep an inventory

Adds sales charge to the NAV

Fund can act as it’s own underwriter if a noload or by charging 12b-1 fees

12b1 funds very common

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24
Q

Investment company Prospectus

A

Must be distributed before or during solicitation for sale

Contains info on fund objective, invest policy, sales charges, MNG expenses and services offered

Also discloses 1-,5-,10- year performance

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25
Q

Invest company’s SAI

A 
Includes:
BS
Statement of ops
IS
And portfolio list
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26
Q

Act of 1940 in regards to financial reporting for invest companies

A

Must be sent semiannually and must include an annual report once a year

Must contain:
The company BS
Valuation of all securities in portfolio as of date in Bs
Income Statement
Compensation paid to BOD and advisory board
Total dollar amount of securities sold

BS must be made available to any shareholder who requests one in writing between semiannual reports

SEC requires:
Factors affecting performance
Line graph comparison to a market index
Name and titles of funds managers

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27
Q

Characteristics of a mutual fund

A

Must redeem shares at NAV and guaranteed marketability

All investors are mutual participants, one common stock share class

May be purchased in full or fractional units

An investor may liquidate without upsetting portfolio balance

Fund distributes a 1099 form explaining tax

Allow small investments ($500 up) and additional investments of $25 and up

Most offer auto reinvestment of cap gains and dividends

May offer break point in fees

May offer reinstatement option where an investor can withdraw and put back in funds without incurring a sales charge

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28
Q

Types of stock funds

A

Most funds have at root common stock that generates growth

Growth fund- Companies that grow rapidly and usually don’t distribute capital gains

Income funds- stresses current income over growth, invest in companies with long history of dividend payment such as utilities

Combination fund- Mix between growth and income

Specialized (sector) fund- example gold funds

Special situation fund- Invest in companies that may be bought, have a patent pending

Index funds- try to mirror an index, low turnover/management costs

Foreign stock fund- principal business activity out of us, long term capital appreciation is main goal

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29
Q

Balanced Fund

A

Invest in stocks for appreciation and bonds for income

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30
Q

Asset Allocation Funds

A

Split between stocks for growth, bonds for income, and money market instruments or cash for stability

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31
Q

Bond funds

A

Main objective is income

Tax exempt funds invest in Municipal bonds or notes and tax exempt money market instruments

US government and agency funds also fall in category

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32
Q

Dual purpose funds

A

Closed end funds can meet two objectives

Income shares that receive all dividends and interest

Capital gain shares that receive all income from portfolio holdings

Two different share classes listed differently

33
Q

Money Market funds

A

Usually no load (no sales or liquidation fee) open End

Investors concerned with liquidity

Interest computed monthly

NAV is set at $1, try not to deviate

SEC requires that it must be disclosed that these funds are not insure by US gov in front cover of prospectus and marketing material

Limited to securities with less than 13 months till maturity with average not exceeding 90 days

Investments include Tbills, commercial Paper, repurchase agreements, and bankers acceptance

34
Q

Lifecycle fund

A

Tailored to meet investment objective of a time horizon

Adjusted quarterly or on some other schedule

Sometimes role into an income fund at end of target

35
Q

Funds of hedge funds

A

Invest primarily in unregistered hedge funds

Hedge funds are usually reserved for accredited investors

Funds of hedge funds give investors exposure

36
Q

Expense ratio

A

All mutual funds have an expense ratio

Divide fund expenses by average net assets

Percentage is based off of units of $100

Stock funds typically are between 1-1.5%
Bond Funds .5-1

37
Q

Turnover rate

A

100% means that the fund cycled all assets on average during the year

Aggressive growth funds typically have a turnover rate over 100%

38
Q

Marketing of Mutual Fund Shares

A
  1. Fund to Underwriter (underwriter takes a concession) to the dealer who then sells for full public offering price
  2. Fund to Underwriter to Investor- cuts out dealer and sales charge is split between dealers
  3. Fund to investor- No load fund that pays all expenses (may also be referred to as no load is under .25% in 12b-1 fees
39
Q

Member vs non member

A

All sales to non members must be made at POP

Members may receive a discount

40
Q

Forward pricing

A

All mutual funds must calculate NAV at least once a day (usually after market close)

The price the customer pays is that next recalculation

NAV is Assets-liabilities (all assets are included regardless of their use)

NAV per share is decreased by distributions of gains

Does not change when shares are redeemed or when securities are bought and sold

NAV per share increases when fund receives investment income

41
Q

Closed end fund sales charges

A

No sales charges on mutual fund side

Investor will pay commission with an agency transaction or a markup/ markdown in a principal transaction as normal

42
Q

Open End funds expenses

A

All sales commisions and expenses are paid from sales charges collected

Three methods to collect:
Front end load (difference in POP and NAV)

Back load (contingent deferred sales load)

12b-1 fees (asset based fees)

43
Q

Front end loads

A

Most common way to pay for services of an underwriter

Taken from the amount invested

Example 10000 invested in front end load of 5% means the customer has an investment of $9500

44
Q

Back end loads (contingent deferred load)

A

Declining sales load charged on the proceeds

Usually structured to drop to zero at the end of an extended holding period

Specified in Prospectus

45
Q

12b-1 Asset Based Fees

A

Mutual fund cannot act as distributor unless it charges a 12b-1 fee

Used for promoting, selling and undertaking activity in distributing shares

Determined annually as flat dollar amount or percentage of average total NAV and charged quarterly

Max 12b-1 is 1% of a Funds net assets (different from normal 8.5% max)

Must be approved at least annually be majority shareholders, BOD and noninterested parties

Can be terminated any time by majority of shares

May not be described as no load of over .25%

46
Q

Sales charge percentage

A

Is a percentage of the POP not the NAV

NAV/ 1-% = POP

Maximum of 8.5% or 6.25%
Max of 8.5% if it:
-Has breakpoints (scale of declining sales charges)
-Rights of accumulation and
-automatic reinvestments of NAV
47
Q

Breakpoints

A

Investment clubs or associations formed for purpose of investing do not qualify for breakpoints

Child and parent only qualify while child is under age

No industry standard, must be disclosed in Prospectus

Purchases may be aggregated to reach breakpoints

May sign a letter of Intent to decrease the overall sales charge

Letter of intent specifies when additional investment will occur within next 13 months

Investor must complete to qualify for reduced sales charge, not binding for customer

Mutual fund holds extra shares in escrow

Letter of Intent can be backdated 90 days but still hold to the 13 months

Breakpoint sale in which a registered rep specifically buys just under a breakpoint is a violation

48
Q

Right of accumulation

A

Allow investor to get to a lower sales charge

Available for subsequent investments
Allow investor to use prior share appreciation to qualify
Do not impose a time limit

Done on amount invested or current NAV

49
Q

Automatic reinvestment of Distributions

A

Shareholder may elect to reinvest distributions instead of receive cash generated

Similar to compounding interest

May only do so if:
Shareholders not participating may participate

Plan described in Prospectus

Security issuer bears no additional cost beyond normal

Shareholders are notified of plan once a year

50
Q

Conversion principles in family of funds

A

May allow the combination of funds to reach a breakpoint

Sponsors allow investors to move from fund to fund

Considered a taxable event

51
Q

Different classes of shares

A

Class A- Front end load, reduced by breakpoints

Class B- back end that declines over time combined with 12b-1

Class C- 12b-1 charged quarterly with small back end load charge at end of first year

Class D- Level load plus a redemption fee

B, C, and D cannot take advantage of breakpoint reductions like A shares

52
Q

Redemption of Mutual Fund Shares

A

Must redeem in seven calendar days of written request

Signature of customer must be guaranteed

Redemption requirement may be suspended if:
NYSE closes outside of normal
Trading on NYSE is restricted or
SEC has ordered suspension of redemptions

All fees and sales loads may not exceed 8.5%

53
Q

Shares sold in 7 business days since purchased

A

Any fees or concessions are given to underwriter

54
Q

Net investment income

A

Dividend and interest income minus operating expenses

Advertising and sales expenses are not included in operating expenses

55
Q

Conduit Theory

A

Under subchapter M of the Internal Revenue Code, if mutual funds serve as a flow through entity, they are only taxed on their retained investment income

Funds that comply are known as regulated investment companies

Requires distribution of 90% of net investment income

If fund distributed only 89%, then it would pay 100% of net invest income

Long term capital gain distributions may be made only once per year

56
Q

Fund yield

A

Annual dividend paid from Net invest income
Divided by
Current offering price (POP)

Yield quotations must disclose
General direction of stock market

Fund NAV at begin and end of period

Percent Change in fund price

Current yield is preceding 12 months

Most distribute quarterly dividend, and all identify where the income is from

IMPORTANT Ex dividend date for mutual funds is set by BOD, usually day after record date

57
Q

Selling dividends

A

A registered rep may not encourage investors to purchase fund shares before a distribution, as it is a violation of FINRA rules

58
Q

Form 1099

A

Details tax information related to distributions for a year

59
Q

Investor cost basis

A

Derived by taking purchase price for shares plus sales charge, reinvested dividends and cap gain distributions

60
Q

Accounting methods for selling shares

A

First in First out- IRS assumed, cost of shares held longest is used to calculate gain

Share identification- investor keeps track of shares purchased, uses info when deciding to liquidate

Average basis- Total cost of all shares/ total

61
Q

Other tax considerations with mutual funds

A

Withholding tax- If investor fails to supply a Social Security or tax Id number, then fund withholds percent of distributions

62
Q

Customers who receive dividends

A

Reduces his proportionate interest in the fund each time a dividend is made

May make additional investment but may have to meet a Funds minimum requirement

63
Q

Voluntary accumulation plan

A

Deposit regular periodic investments on a voluntary basis

Many funds offer automatic withdrawals

May require a minimum initial purchase or additional purchase amounts

A missed payment is not penalized because it is voluntary

64
Q

Dollar cost averaging

A

Person invests identical amounts at regular intervals

Allows investors to purchase more shares at lower amount and less at higher

Results vary depending on the market

65
Q

Fixed dollar withdrawals

A

Withdrawls plans are usually offered for free if offered at all

Fund liquidates enough shares to send the same sum, liquidates same percentage or number of shares or at a same time

Shares usually have to meet a minimum amount

Most funds discourage reinvesting after plan starts

66
Q

Registered reps using a withdrawal plan must

A

Not promise a guarenteed return

Possible to overwithdraw

Never use charts or tables unless cleared by SEC

67
Q

Quoting a Mutual Fund

A

Bid Price is the NAV

Offering price is the NAV plus the maximum sales charge applicable to a fund

68
Q

Sales charge%

A

Sales charge / POP

69
Q

Index tracking funds

A

Are not investment company products but have similar characteristics

Can create additional shares and are publically traded

Used to:
Follow industry trends, balance a portfolio, speculative trade and hedge

Have intraday trading, can be purchased on margin and be short sold unlike mutual funds

Spiders track the S&P

Many are ETFs and one of the most popular is the Qs which tracks the Nasdaq 100

70
Q

Leveraged Funds

A

Attempt to deliver a multiple return

Most use derivatives (options, futures and swaps to enable them to achieve the stated goal

71
Q

Inverse funds

A

Try to deliver returns opposite of the benchmark

72
Q

Hedge funds

A

Unregulated by US securities law

Usually suitable for sophisticated investors

Very nature of the investment is usually considered speculative

May have lock up provisions that are dependent on the strategy of the hedge fund

May hold blind pool Securities that are like blank check Companies only an industry is indicated

73
Q

Holding company Depository receipts

A

Broker dealer issued products traded on exchange

Represent ownership in underlying stock

No capital gain distributions

Underlying company getting sold would mean the customer owning the holder would receive the security

Rebalancing occurs manually in a HOLDR

Can only be purchased in round lots

Owners have a right to vote and receive all disclosure material unlike in a mutual fund or etf

Flat fee charged quarterly per round lot of HOLDRs; fluctuates with value and is decreased by dividends

74
Q

Letter of Intent for 15000

A

Initial Invest of 9000
Dividends of 720 during 13 month period

Still need to invest the 6000 though the value of the shares is now 9720

75
Q

Major difference between closed end and open end mutual funds

A

Open End companies continuously offer their shares

Closed end have a limited number of shares

76
Q

A fund must notify its shareholders of their ability to reinvest dividends

A

Annually

77
Q

Client must receive the prospectuses

A

Before or during the sales solicitation

78
Q

A management company receives a fee based on

A

Average annual net assets of the fund

79
Q

A member receiving a discount must

A

Have the discount in writing and provide for a refund of the concession if the shares are redeemed in 7 business days

Series 7- Passed with 83% (19 decks)

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