Chapter 4 - Investment Companies

Question 1

investment companies are organized how?

Answer 1

either a corporation of as a trust

• Individual investor’s money then is pooled together in a single account and used to purchase securities that will have the greatest chance of helping the investment company reach its objectives
• All investors jointly own the portfolio that is created through these pooled funds
• Each investor has an undivided interest in the securities
• No single shareholder has any right or claim that exceeds the rights or claims of any other shareholder regardless of the size of the investment
• They offer individual investors the opportunity to have their money managed by professionals that may otherwise only offer their services to large institutions
• Through diversification, the investor may participate in the future growth or income generated from the large number of different securities contained in the portfolio
• Diversification and professional management should contribute significantly to the attainment of the objectives set forth by the investment company

Question 2

Securities Act of 1933 Says that all companies are required to do what?

Answer 2

• register with the securities exchange commission and to give all purchasers a prospectus

Question 3

Investment company act of 1940 breaks down investment companies into what 3 different types?

Answer 3

• Face-amount company (FAC)
• Unit investment trust (UIT)
• Management investment company (Mutual funds)

Question 4

Face-amount company (FAC)

Answer 4

• It is a contract with the investor and issuer of a face-amount certificate to receive a stated or fixed amount of money at a stated date in the future
• In exchange for this future sum, the investor must deposit an agreed lump sum or make scheduled installment payments
• These are rarely issued today because most of the tax advantages that were once offered have been lost through changes in the tax laws

Question 5

Unit investment trust (UIT)

Answer 5

• This will either invest in a fixed portfolio of securities or in a non-fixed portfolio of securities
• Fixed UIT
  
  • Traditionally will invest in a large block of government or municipal debt
  • Bonds will be held until maturity and the proceeds will be distributed to investors in the UIT
    
    • Once distributed, the UIT will have achieved its objective and will cease to exist
• Nonfixed UIT
  
  • It will purchase mutual fund shares in order to reach a stated objective
  • It is also known as a contractual plan
• Both types are organized as a trust and operate as a holding company for the portfolio
• They are not actively managed
• They do not have a board of directors or investment advisors
• They issue units of shares of beneficial interest to investors which represent as undivided interest in the underlying portfolio of securities
• Must maintain a secondary market in the unit or shares to offer some liquidity to investors

Question 6

Management investment company (Mutual funds)

Answer 6

• They employ an investment advisor to manage a diversified portfolio of securities designed to obtain its stated investment objective
• May be organized as either an open-end or closed-end company
  
  • Main difference is how the shares are purchased and sold
  • Open-ended
    
    • Offers new shares to any investor who wants to invest
      
      • Known as continuous primary offering
    • Because the offering of new shares is continuous, the capitalization of the open-end fund is unlimited
      
      • Meaning they may raise as much money as investors are willing to put in
    • Must repurchase its own shares from investors who want to redeem them
    • No secondary market for open-end mutual fund shares
    • Shares must be purchased from the company and redeemed to the fund company
  • Closed-end
    
    • Offers common shares to investors through an initial public offering just like a stock
    • Its capitalization is limited to the number of authorized shares that have been approved for sale
    • Shares will trade in the secondary market in investor-to-investor transactions on an exchange on in OTC, just like common shares

Question 7

Open end VS Closed end

Answer 7

Question 8

Diversified VS Nondiversified

Answer 8

• The investment act of 1940
  
  • Laid out an asset allocation model that must be followed in order for the find to call itself a diversified mutual fund
  • It is known as the 75-5-10 test which includes:
    
    • 75%
      
      • Of the funds assets must be invested in securities of other issuers
      • Cash and cash equivalents are counted as part of the 75%
      • A cash equivalent may be a T-bill or a money market instrument
    • 5%
      
      • May not invest more than 5% of its assets in any one company
    • 10%
      
      • May not own more than 10% of any company’s outstanding voting stock

Question 9

Investment company registration are regulated by what?

Answer 9

• Securities act of 1933
• Investment company act of 1940

Question 10

The company must register with the SEC if the company what?

Answer 10

• operates to own, invest, reinvest, or trade in securities
• As an investment company if the company has 40% or more of its assets invested in securities other than those issued by the US government of one of the company’s subsidiaries

Question 11

a company May not register with the SEC unless it has the following?

Answer 11

• Minimum net worth of $100,000
• At least 100 shareholders
• Clearly defined investment objectives
• NOTE:
  
  • If it does not have these things, it must have them in 90 days

Question 12

• The company is considered to have registered when the SEC receives its notice of registration which contains:

Answer 12

• Type of investment company (open-end, closed-end, etc.)
• Biographical information on the officers and directors of the company
• Name and address of each affiliated person
• Plans to concentrate investments in any one area (ex. Sector fund)
• plans to invest in real estate or commodities
• Borrowing plans
• Conditions under which investment objective may be changed through a vote of shareholders

Question 13

Once a company is registered, the company can do what?

Answer 13

• Raise money through the sale of shares
• Lend money to earn interest
• Borrow money on a limited basis
• May lend money to earn interest such as by purchasing bonds or notes
• May borrow money for such business purposes as to redeem shares
  
  • If they borrow, it must have $3 in equity for every dollar that they want to borrow
  • Meaning, the company must maintain an asset-to-debt ratio of at least 3-to-1 or of at least 300%

Question 14

Once registered, a company can NOT:

Answer 14

• Lend money to employees
• Take over or control other companies
• Act as a bank or a savings and loan
• Receive commission for executing orders or for acting as a broker
• Continue to operate with less than 100 shareholders or less than $100,000 net worth
• Sell securities short
• Buy securities on margin
• Maintain joint accounts
• Distribute its own shares

Question 15

All the following are exempt from the registration requirements of an investment company:

Answer 15

• Broker dealers
• Underwriters
• Banks and savings and loans
• Mortgage companies
• Real estate investment trusts (REITs)
• Security holder protection committees