Chapter 4 Features of Investment Companies Flashcards
Investment Company Act of 1940
Defines an investment company
- Has 40% of its total assets held in investment securities
-$100,000 in net assets
-100 or More investors
Management Companies
Organized as a corporation, operates under the direction of a board of directors, and issues shares of undivided interest to investors.
- Portfolio manager
Close end Management Company
Single primary offering to raise capital
-publicly traded funds traded in secondary market.
Open End Management Company
is commonly known as mutual funds.
- Common Stock offering only
- Unlimited - continuous Primary Offering
- Every share must be sold by prospectus
- Redeemable Security
- Referred to as a mutual funds
- Pricing based on NAV and POP
- Full or fractional shares may be purchase
What is a Diversified Investment Company as defined by the Investment Company Act of 1940?
“75-5-10” Rule
75% of Total assets must be invested so that no more than 5% of its total assets are invested in the securities of any one corporation.
Investments will not cause the fund to own more than 10% of the voting stock of any one corporation
Investment Advisor
The firm is responsible for managing the fund’s investment portfolio and conforming to the investment objective established.
Investment Advisor Fee
Is based on a percentage of total assets under management
- The fee is paid regardless of overall profit/loss
Custodians
An organization or individual that safeguards the cash and securities owned by the fun. Collects interest and dividend payments from issuers and makes or receives payments.
- Trust companies or commercial banks
Transfer Agent
Performs all recordkeeping and customer service functions for the fund, and keeps track of the number of shares owned by each investor.
Expense Fund
Operating expenses of the fund
- Board of directors stipends
- Investment adviser management fees - largest components
- Custodial services
- Transfer agent fee
Expense Ratio
Fund Expenses / Average Net Assets = Expense Ratio
What is the underwriter?
FINRA member / Distributor
- Earn compensation as a part of the sales charge for marketing and selling the fund
How is retail communication handled?
All retail communication used by registered broker-dealers is subject to FIRNRA filing and review
- Communication is based on FINRA dealing and good faith
Investment objective of the Fund
- Objective is stated in the prospectus
- ## Determined by the board of directors
Prohibited Activities for Mutual Funds
- Buying on Margin
- Selling on Margin
- Selling an uncovered (naked) Options contract
What is covered call writing?
Options strategy
- When the funds holds common stock and then the fund sells a call against the common stock.
What is NAV?
Is the fundamental value of the fund.
- Calculated at the end of the day.
NET ASSET VALUE = NET ASSETS / NUMBER OF SHARES OUTSTANDING
What is POP
The price the customer pays when purchasing the shares of a mutual fund.
- The POP will change on a day-to-day basis
What is a Sales Charge (Sales Load)?
Primary compensation paid to the underwriter and broker dealers for marketing, advertising, and selling fund shares to the public.
- POP cannot exceed the NAV by 8.5%
12b-1 Asset based Distribution Fee
These are the asset based fees and are permitted if the fund has adopted a 12b-1 plan authorizing their payment
- Marketing, advertising, and other costs of distributing fund shares
- Advertising includes the printing and mailing of prospectuses and sales literature to new investors
Front-End Load (Class A Shares)
Sales charge is assessed at the time of purchase
- Often have lower annual expenses and 12b-1 fees compared to other classes
- Receives the full redemption value
Back-End Load (Class B Shares)
Assess a back-end sales charge giving investors the ability to have their entire amount invested immediately into the fund. (The longer you are invested the lower the sales charge)
Back-End Load = Contingent deferred sales Charge: only charged if the customer fails to stay invested in the fund for a prescribed minimum period of time.
What is conversion Privilege?
Class B shares are converted to class A shares once the CDSC drops to zero
Level Load ( Class C Shares)
Pays a fixed amount (%) per year.
- 1% fee + 12b-1 fees
- Suitable for investors with very short horizons
- Cannot convert to class A Shares
No-Load
No sales charge because the investment company is the distributor. NAV=POP
- Can assess a 12b-1 fee no greater than 25 basis points a year
Reduced Sales Charges
This is an incentive to investors who purchase Class A shares
- May be required to make minimum purchase
- Larger the investment, same fund family = Lower Sales Charge
What must a fund offer to charge the maximum 8.5% sales charge?
-Rights of Accumulation
- Breakpoints
Breakpoints
- Only for class A Shares
- Can be attained by adding the total amount invested in the fund family
- By Reaching the breakpoint dollar limit, an investor is entitled to a lower sales charge for future purchases
- Must be disclosed at the time of sale
Break Points Sale Violation
When a registered representative purposely makes a sale just below the breakpoint to earn a higher sales load
- PROHIBITIED BY SEC AND FINRA
Letter of Intent (I-OWE-YOU)
This allows the investor to combine an initial investment with a future investment and immediately qualify for a reduced sales charge on the initial investment.
- 13 MONTH LIFE
- Can backdate up to 90 days
- New money only
Rights of Accumulation (ROA)
Allows an investor to add their existing account balances with their additional purchases to qualify for breakpoints on any new money invested.
- Must be offered for at least 10 years
How can you make exchanges (Net Transactions) within the same fund family?
The investor will purchase the new fund shares at NAV without paying sales charge assuming a sales charge was assessed on the previous fund owned.
- For taxes purposes, exchanges are treated as sales
Reinstatement Privilege
Allows mutual funds to make it easy for people to replace money that they have previously withdrawn without incurring a sales charge.
- Withdrawn money must be replaced promptly (30 days) to qualify and on an infrequent basis.
Prospectus
- Is a comprehensive risk disclosure document that provides potential investors with the information deemed by the regulators as necessary to making an informed purchasing decision
- Contains funds objectives, investment policies, restrictions, and disclose all costs and fees.
- Mutual funds update their prospectuses every 16 months
Summary Prospectus / Mutual fund policies
Is an abridged form of the statutory prospectus
- Includes an application to open a new account and is an offer to sell
Must include:
1) The funds investment objective
2) Fees and expenses
3) Investment risks and performance information
4) Investment advisors and portfolio managers
5) Information on buying and selling shares
6) Tax information
7) Details on financial intermediary compensation
What are the annual and semiannual reports?
are financial reports cards for the fund that contain information like that found in the prospectus. For up to 6 months
- audited annual report to SEC
- audited disclosure documents
What is an nonqualified opinion?
Its states the auditor agrees with financial information.
What is qualified opinion?
Auditor disagrees with some or all financial reporting.
What is the Statement of Additional Information?
Supplementary information for prospectus.
What are the Mutual Fund advantages?
- Professional Portfolio Manager
- Diversification
- Minimum Investment
- Safekeeping of Portfolio Securities
- Reduced Sales Charge
- Exchange Privilege
- Reinvestment
- Reinstatement
- Liquidity
- Systematic Purchase and Withdrawal Plans
What is the Right to Receive Dividends?
- Declared by the board of directors
- is a share in profit from the fund.
- Earnings from fund of securities held.
