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Series 7 > Chapter 4- Investment Companies > Flashcards

Chapter 4- Investment Companies Flashcards

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Series 7 Top-off Exam flashcards
1
Q

What is an investment Company

A

A financial institution principally engaged in investing in securities. They pool the money of investors and invest fund in securities that attempt to achieve the stated goals of the investment company.

Regulated by Investment company act of 1940

Not brokerage companies, insurance companies or banks

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2
Q

Advantages and design of investment companies

A

Investment companies are designed for long term investments
Advantages of investment companies are they offer professional management, liquidity and diversification

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3
Q

Classification of investment companies

A

Face amount certificates companies
Unit Investment Trusts (UITs)
Management companies

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4
Q

Face amount certificate companies

A

issue debt certificates at a discount
investors hold certificates until maturity
Investor then redeems certificate at maturity for face value

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5
Q

Unit Investment Trusts (UITs)

A

Issues only redeemable units
Generally have fixed portfolio of bonds (muni or corporate bonds)
Supervised but not managed. Securities may be sold but money is not reinvested
Change little to no management fee and low sales changes
Have a trust indenture and a board of trustees
Pay interest not dividends
Trust terminates once all bonds have matured
May have quantity discounts

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6
Q

Management companies

A

Issue and redeem shares every business day
Open ended structure
Closed ends will issue shares once and then are sold on the secondary market
At least 75% of assets regulated, and not more then 5% of those can be in a single company and can not own more then 10% voting stock of a single company
Most funds are diversified
Can be non-diversified where assets are not regulated

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7
Q

Open end investment company AKA

A

Mutual fund or open end managment company.

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8
Q

Where does the mutual in mutual fund come from

A

Shareholders share proportionately in the fund gains losses and income

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9
Q

Mutual Fund (open end fund) Attributes

A

-Considered highly liquid
-Not FDIC insured
-Issue only redeemable shares, non-marketable shares must be returned to the issuing company
-May only issue voting common shares
- Net Asset Value (NAV) per share = (total assets of the fund - total liabilities of the fund)/ total number of shares outstanding
- NAV reflects closing market value of all securities in the portfolio + interest or dividends received

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10
Q

Mutual Fund: Bid and ask price

A

Bid = Net asset value(NAV) = redemption Price

Ask = NAV + Max sales load = offering price

On a No-Load fund the bid and the ask are the same

Calculated daily usually at the close of NYSE

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11
Q

Buying Mutual Funds and pricing

A

Forward pricing is used. Investor gets the next calculated bid or ask price (as of market close) after the order is entered

Can not be purchased on margin

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12
Q

Mutual Fund regulations

A

All issued shares are considered new shares so they are regulated by The Securities Act of 1933 Prospectus Delivery Regulation

Maximum FINRA sales load 8.5%
Maximum Investment company act sales load 9%

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13
Q

Closed end fund attributes

A

Issue marketable shares (not redeemable)
Active secondary market
NAV does not always relate to bid and ask price. Moves with supply and demand
If NAV > ask it must be a closed end fund
No sales load, trade on commission
Fixed number of shares issued
Can issue common stock, preferred stock, and bonds
The “% diff” in the price quote is referring to the change in value from the previous days close

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14
Q

Business Development Companies

A
  • A closed end fund that provides small businesses with debt capital that could not otherwise obtain it
  • good for investors with high risk tolerance
  • Required to distribute 90% of income as dividends
  • Considered a sub prime lender and bond would be unrated or “junk” bonds
  • Borrow at a low interest rate and lend at a high interest rate and make money on the spread
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15
Q

Open end and Closed end fund

A

Both have market risk
Have voting rights, get to vote to elect a board of directors, the objectives of the fund and change independent advisory firm used by the fund

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16
Q

Diversified common stock fund

A

Invests in common stock in many different companies and industries
Performance is directly tied to the stocks in the portfolio

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17
Q

Specialized / special situation / sector Fund

A

Invests primarily in stocks in companies in one industry or geographic area
considered the RISKIEST type of fund due to their concentration in one industry
Susceptible to Marketability risk

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18
Q

Balanced Funds

A

Most conservative and least volatile fund
Mix of common stock, preferred stock, and bonds
Least volatility but least appreciation

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19
Q

Income Fund

A

Objective is to maximize income
Has dividend paying stocks and high yield bonds

Can be an equity income fund that would look for both income and appreciation

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20
Q

Growth Fund

A

Objective to have capital appreciation
Generally low or no dividends and has lower yields
Investors in this type of fund would usually reinvest dividends for additional growth
Usually invest in small cap common stock (leading to higher volatility)

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21
Q

Blue Chip Fund

A

Invest in Blue Chip Stocks

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22
Q

Gold Funds

A

Invest primarily in stocks of companies in the gold industry
Usually pay little or no dividend
Sometimes considered a specialized/sector fund

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23
Q

International Fund

A

Invests in stocks and bonds of foreign governments and companies
Higher income in US dollars when foreign interest rates are high and US dollar is weak
AKA- overseas funds
No investment in US government or corporate securities

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24
Q

Global Funds

A

International fund that also invests in US government and corporate securities as well

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25
Q

Index Funds

A

Attempts to mirror a particular index
No active portfolio manager
Expense Ratios are generally lower then most other funds

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26
Q

Bond Funds

A

Invest in a portfolio of bonds
Could be a specialized bond fund or a diversified bond fund
Should consider interest rate fluctuation when investing in a bond fund.
Value of the fund moves inversely to interest rates
Best time to invest is when interest rates are high and expected to decline

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27
Q

Municipal Bond Fund

A

Specialized bond fund that invests only in municipal bonds
Dividends distributed are exempt from federal income tax (so lower dividend yields are expected) but appreciation is taxed federally

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28
Q

Interval fund

A

A fund that periodically offers to repurchase shares from shareholders
Shareholders are not obligated to sell shares
Details of repurchase timing and pricing is set in fund prospectus

Considered closed end fund but function like an open end fund in that:
Shares do not trade on the open market
Shares are repurchased at NAV
Shares are continuously offered at a price based on the funds NAV

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29
Q

Money Market Fund

A

Invest is high quality short term (less then 12 month) debt instruments
Operating expense is high and has a significant impact on the total yield
Considered the most liquid mutual fund because customer can make deposits and withdrawals at any time and they offer safety since the debt is short term
credits dividends daily and pays dividends monthly
Taxed as dividend income
Capital gains are unlikely
Average 90 day or less maturity
Offer minimal risk
95% of investments must be in the top two tiers of ratings by a NRSRO (Nationally Recognized Statistical Rating Organization)
No Sales Loads
Minimum withdrawals are $500
NAV is $1.00 per share
Invests in T-Bills, CDs, commercial papers, Bankers acceptance, and Eurodollars

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30
Q

Hedge Funds

A

-Neither a closed nor open end fund
-Typically a distraction in fund questions
-Form of investment vehicle for affluent or semi affluent investors
-Not considered an investment company under the investment company act of 1940. Far fewer regulations
- Established as Limited Partnerships
- Use derivatives, private equities, currencies, long and short positions and leverage
- Subject to much higher risk
Not very liquid, able to sell only monthly quarterly or annually depending on the fund
-Generally limited to Accredited investors and have high minimums

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31
Q

Exchange Traded Funds (ETFs)

A

Similar to normal index funds
Difference is ETF has shares that trade like common stock shares
Can be passive or active
Passive will mimic an index, transactions will be minimal and will match the index
Active will try to beat their index by using a portfolio manager. To accomplish this they do more trading and are more expensive and volatile.

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32
Q

ETF characteristics

A

Bought and sold though out the trading day (unlike mutual funds that only trade at the end of trading)
Can be bought on margin and can be sold short
Annual expenses are generally low
Commission charged like on common stock, no sales load
Dividends are possible (but not usual)
Settlement is T+2
Options are available

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33
Q

Exchange traded notes (ETNs)

A

ETNs are debt instruments issued by banks
Bank promises to pay back principal less investor fees at maturity
Performance of ETN is linked to a specific index

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34
Q

Exchange Traded Notes (ETNs) characteristics

A

Unsecured notes, principal not protected, but do participate in performance of a specific index
If index declines the value of the ETN does as well. This means all of your principal may not be returned at maturity
ETNs trade like stocks and can be sold short
ETNs have a final maturity and can be callable

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35
Q

Hedge Funds and tax

A

Generally a pass through tax entity, Fund is not taxed but the people that participate in the fund are. Reported on a K-1

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36
Q

Qualified Clients

A

Net worth or $2.2 million dollars or more
or
$1.1 million with that specific investment advisor

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37
Q

Hedge fund comparison

A

Since Hedge funds have less regulations they do not have standardized performance information so you can not simply compare one hedge funds performance to another

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38
Q

Fixed Income (bond) ETFs

A

Gives investor the opportunity to invest in bonds without investing in 1 particular bond

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39
Q

Leveraged ETFs

A

A non-traditional ETF
Borrow capital with the goal of generating higher returns, gains need to be higher then borrowing cost to be successful
Also use derivatives such as futures and options
Because of leverage gains and losses are magnified
Maintenance margin requirements are higher for Leveraged ETFs (double for 200% leverage and tripled for 300% leverage)

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40
Q

Inverse ETFs

A

Non-Traditional ETF
Deliver the opposite of the performance of the benchmark
AKA- short ETFs
Can be leveraged
Uses derivatives more heavily then leveraged ETFs

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41
Q

Non-Traditional ETF Considerations

A

More volatile and risky then regular ETFs
Reset or Rebalanced daily
Most designed for single day trading
FINRA believes that leveraged and inverse ETFs are not suited for retail investors that plan on holding them for more then 1 day

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42
Q

ETN counter party risk

A

ETNs have counter party risk because liability to pay rests with the bank the and ETNs are unsecured
If bank issuing ETN goes bankrupt then holder of the ETN becomes a creditor of the bank

43
Q

ENT Sectors

A

Commodities
Currencies
Emerging Markets
Strategy/Index

44
Q

ETN Taxation

A

The IRS has not made a final ruling on ETNs
Therefore ETNs do not pay dividends or have a coupon rate and the holders enjoy the benefits of paying long-term capital gains rates on ETNs held for more then 1 year

45
Q

A Fund of Funds

A

A pooled investment product that invests in other pooled investment products
No additional restrictions if mutual funds are the focus
If holding hedge funds in the funds then the investor must still meet accredited investor status

46
Q

Capital gains distribution from investment companies

A

Realized long term on the portfolio
Always long term to the investor
May be cash or shares
Taxable each year
Must distribute 100% of gains to investors at least once a year
When paid NAV of the fund goes down
Reinvested at NAV if reinvested, and no sales load is charged

47
Q

Investment Income or dividends in investment companies

A

Always taxed as ordinary income
Fund deducts its operating income from dividends before distributing them to shareholders
Must pay out at least 90% of the net investment income to be exempt from paying tax on the income distribution
Reinvested dividends will increase investors cost basis
Mutual Fund sets their own Ex-dividend date

48
Q

Expense Ratios on investment companies

A

Measures funds operating efficiency or operating cost
most are low (less than 1%)
Higher on mutual funds then UIT because UITs have no management fees
Sales load are not included in expense ratios

Formula is :
Operating expenses/Average Net Assets = Expense ratio

49
Q

Total Return of an investment company

A

Best measurement of fund performance. Considers funds dividends, capital gains and loses, and changes in NAV.
Yield is based on dividends ONLY and if that is used in literature total returns must also be disclosed

50
Q

Cost Basis on investment Companies

A

Can use FIFO
Specific Identification
OR Average Cost
Must choose 1 and stick with it

LIFO is not allowed

51
Q

DRIP- Dividend Reinvestment Plan

A

Long term investors who are interested in accumulating more stock
Dividends and capital gains distributions are all reinvested in the fund

52
Q

Taxable events with investment companies

A

Dividend payments
Capital gains distributions
Switch from one fund to another
Redemption of fund shares

53
Q

Wash Sale Rule

A

61 days (30 days before, trade date, 30 days after)
Substantially significant is convertible bonds, convertible preferred stock, options, or the same common stock

54
Q

Conversion/Switching/ Exchange Privileges

A

Some companies allow switching between fund within the same company
May have a charge but not a full sales load
Viewed by the IRS as a sale and is taxed as such

Note: Typically the cheapest way to switch out of a fund.

55
Q

Classes of Shares and what metric you use to decide

A

Class A
Class B
Class C

Length of holding period determines the class shares you should purchase

56
Q

Class A Shares

A

Charge an upfront sales charge that max out at 8 1/2%
Typically lower 12b1 fees.
If investing a large amount at once will benefit from break points.

Best option for long term holding periods

57
Q

Class B Shares

A

Back end loaded funds with contingent deferred sales loads
Expenses are typically higher then Class A shares
Sales load is charged on a declining scale, the longer you hold it the lower it gets
Sales charges are based on the NAV at the time of purchase or sale, whichever is lower
Charge higher 12b1 fees then class a shares

58
Q

Class C Shares

A

No upfront or back end sales load
Have the highest annual expense charges
Generally best choice for short term investor

59
Q

Fund Objectives

A

Must be in the prospectus
Can only change if a majority of shareholders vote to authorize a change
Success of a fund is if they have met their objectives not compared to other funds
R-Squared- a commonly used statistic used to show how much of the funds movement in price is explained by the benchmarks movement in price
Minimum purchase amount and quantity discounts must be disclosed here

60
Q

Prospectus is the best places to find…

A

A funds investment objective and the funds performance

61
Q

Mutual Fund 12b1 fees

A

Annual charge against funds assets that are more advertising and marketing
FINRA max fees - 0.75% of funds average NAV for funds paying marketing and distribution expenses
0.25% of funds average NAV for no load fund

62
Q

Fund Application

A

To purchase funds an investor will submit a “fund application not an order ticket

63
Q

Break point

A

Reduced sales charges for a larger quantity of investment

usually obtained through a letter of intent or rights of accumulation

64
Q

Letter of Intent

A

13 month period to reach a break point amount
Can be backdated 90 days
Must be informed of breakpoints or broker is in violation of FINRA rules

Investment Clubs and investment advisors purchasing for a client are not eligible for break point discounts

65
Q

Failure to meet a letter of intent

A

An escrow account is created when you submit a letter of intent. If you fail to meet the objectives in a letter of intent the escrow account is liquidated to cover the remaining sales charges due

66
Q

Break point sale

A

Occurs if investor is not informed on how to achieve the break point discount
Usually signified by an amount that is just below a breakpoints discount

Break point sales are prohibited

67
Q

Rights of Accumulation

A

Permits a reduced sales charge if the total amount invested plus the additional investments combined exceed the sales charge break point
Family accounts can be combined
If account declines, shares can not be valued lower then their purchase price

68
Q

Letter of Intent (LOI) VS Rights of accumulation (ROA)
Valuing

A

LOI are valued based on the actual money that you invested

ROA use current market value of the account

69
Q

Rights of Reinstatement

A

A Fund family may allow customers to redeem or sell shares in a fund and reinvest some or all of the proceeds without paying a sales charge or recoup some or all of a contingent deferred sales charge

70
Q

Right of Reinstatement Eligibility

A

Made in specific time period
Must take place in the same account
Shares must be subject to a front end of deferred sales charge
Must comply with any other terms set by the investment company

71
Q

Net Asset Value Transfer

A

Allow the purchase of class A Shares without paying the front end sales charge if the customer purchased the shares with proceeds from the sale in a different mutual fund by the same fund family in which the investor already paid a front end or back end sales charge
Typically required to be completed within 30-90 days of the initial sale

72
Q

Redemption and Redemption Fees

A

Fees charged on the redemption or liquidation of mutual fund shares
Based on NAV and usually charged by No-Load funds
Open end. No Load, and UITs issues redeemable shares. Closed end do not so there is no redemption fees
If done within the first 7 days all commissions and fees are returned to the investor
Redemption fees and penalties must be disclosed in the funds prospectus

73
Q

Inherited Mutual Funds

A

Automatically long term
Step up in basis to market value on the date of death

74
Q

Mutual Funds and the Securities Act of 1933

A

Requires the delivery of a new prospectus
Can be a summary prospectus or statutory prospectus

75
Q

Summary Prospectus contains

A

Investment objectives
Fee Table
Investment risk and performance
Management- investment advisors and portfolio managers
Purchase and sales of fund shares
Tax Information
Financial intermediary compensation

76
Q

Summary prospects cover page must contain

A

The Fund Names
Class share or shares offered
Identify that it is a summary and where the full prospectus can be found
Date of first issue use of the summary prospectus
A legend- and this must provide a website and email address where investors can obtain additional information including the statutory prospectus

77
Q

Statutory Prospectus

A

Must contain everything from the summary prospectus but in more detail
Must include:
Minimum purchase requirements
Quantity discount amounts (Break points)
Fund management fees
Fund Financial Statements

DOES NOT includes NAV since that changes daily

78
Q

Delivery of Prospectus

A

satisfied by sending out, or giving directly, the summary prospects to investors and posting the statutory prospectus on the internet

79
Q

Prospectus and the internet requirements

A

Current summary prospectus, statutory prospectus, Statements of additional information and Most recent annual and semi annual report to shareholders must be:
accessible
free of charge
and remain up for at least 90 days
on the website address on the cover page of the summary prospectus

80
Q

Mutual fund delivery of information requirements

A

Funds have 3 business days after receiving request for information to send it out. Information must remain available for a minimum of 6 months after the date an email was sent

81
Q

Prospectus delivery required of

A

Variable annuities
Face amount certificate companies
open end investment companies
Unit Investment Trusts (UITs)
Contractual plans

Closed end funds no longer need to deliver hard copies upon sale. Having it posted on the internet is now satisfactory. But a hard copy must be provided upon request

82
Q

Investment Company act of 1940

A

Provides investors with full and fair disclosure
Require Information to be sent to SEC at least annual, but usually quarterly
Information to be sent to investors semi annually
Continually offer a prospectus that is updated at least annually (can not be used if over 16 months old)
No predictions or projections on investment Companies

83
Q

Investment Company act of 1940 and purchase/ redemption of shares

A

Customer must pay for shares within 2 business days of the trade
Customer must be paid within 7 Calendar days of redemption of shares

84
Q

Continuing commissions

A

If there is a Bona Fide contract in place before retirement commissions may be paid to a RR or their beneficiaries after the RR retires, only on funds

85
Q

Cash Payments from an investment company

A

Must be disclosed in the prospectus
may only be paid by the member firm not the fund directly
Includes discounts, concessions, fees, commissions, overrides, sales loads, loans and employee benefits

86
Q

Non-Cash payments

A

Are no required to be in the prospectus
include up to $100/person/year, merchandise and prizes, travel expenses associated with educational meetings and occasional meals

87
Q

Restricted compensation

A

Members and associated person can never be compensated with securities of any kind

88
Q

Mutual Fund switching

A

Recommending a customer switch from one family of funds to another without investment justification is a violation
imposes sales charges and tax liability unnecessarily
Mutual fund investing should be long term not short term

89
Q

Comparing Investment companies or funds

A

Statement of why the comparison is being made must be present
Data comparisons must be for the same time period
Investments must be similar
Performance comparisons are allowed but must not be misleading
Investment objectives must be disclosed

90
Q

Advertising of Mutual Funds

A

Must include Standardized performance index
Maximum sales charges
Total annual fund operating expense ratio

91
Q

Investment Company Administration

A

Must have a minimum Net worth of $100,000 before they can be offered to the public
40% of the board must be non-affiliated
Cash and securities must be held at a custodian, usually a bank

92
Q

SEC “Disclaimer” or “non-approval” clause

A

Must be contained in all prospectuses

Must be on front page of prospectus

Unlawful for a sales person to represent that the SEC has approved a security

93
Q

Rule 12b1

A

Allow managers to dip into the funds assets annually to pay for marketing, distribution and other promotional expenses including commissions
Must be disclosed in the prospectus but the way they are being used do not have to be disclosed
Must be approved annually by the shareholders

94
Q

Responsibilities of a Fund’s Investment manager

A

Manages the funds portfolio of securities
Is paid a management fee based on the average daily net asset value of the fund
Investment contract is voted on by the board of directors for an initial 2 year contact and then yearly after that

95
Q

Underwriter/ Distributor/ Sponsor responsibilities

A

Buys shares from the fund at NAV and sales them to the public with a sales charge or ti a dealer with a discount
Receives an underwriting concession that is contained within the sales load

96
Q

Custodian Responsibilities

A

Typically a bank
Safekeeping of the cash and securities in a portfolio
Can serve as transfer agent, registrar, and/or dividend disbursing agent
May NEVER be associated with sales or call a distributor

Their main function is to provide record keeping and clerical services

97
Q

Transfer agents responsibilities

A

Issues fund shares
Redeem fund shares
Disburses dividend and capital gain distribution and keeps records of these
Sends statements to shareholders and keeps records of purchases and redemption

98
Q

Funds Fees are paid …

A

out of the funds assets

99
Q

Types of systematic withdrawal plan

A

Fixed Percentage Plan
Fixed Number of Shares Plan
Fixed Dollar Plan

100
Q

Systematic Withdrawal Plan tax treatment

A

May be taxed as capital gains on the sale of shares
or
as ordinary income if the withdrawal was made from investment income

101
Q

Charateristics of Unit Investment Trusts (UITs)

A

They are diversified portfolios of Municipal and Corporate bonds
One of three types of investment companies with no management fee and a low percentage sales charge that invests in a fixed portfolio of corporate or municipal bonds.
They are supervised but not managed

102
Q

Open end investment companies can not issue…

A

Senior Shares

103
Q

Mutual Funds operating expenses are paid from…

A

Investment Income and Dividends

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