Chapter 4 - Investment Company Securities

Question 1

When is a mutual fund allowed to buy securities on margin?
A) Only with special permission from the SEC
B) Only after opening a margin account
C) Only in the first 10 trading days of each month
D) Never

Answer 1

Correct Answer:
D) Never

Answer Explanation
Mutual funds are prohibited from selling securities short and also from buying securities on margin or with borrowed funds.

Textbook Reference
Please see textbook section 4.2.3

Question 2

Open-end and closed-end company investments share all of the following characteristics EXCEPT
A) Professionally managed by an investment manager subject to registration under the Investment Company Act of 1940
B) The NAV per share is calculated by subtracting the fund liabilities from the fund’s assets and dividing by the number of shares outstanding
C) Shareholders own an undivided interest in all securities with the portfolio
D) They issue a single class of shares

Answer 2

Correct Answer:
D) They issue a single class of shares

Answer Explanation
Open-end companies commonly issue A, B and C shares which reflect different types of sales charges. Closed-end funds issue one type of share class only.

Textbook Reference
Please see textbook section 4.6

Question 3

Intra-day trading is available for both
A) Closed-end funds and UITs
B) Closed-end funds and hedge funds
C) Closed-end funds and ETFs
D) Open-end funds and ETFs

Answer 3

Correct Answer:
C) Closed-end funds and ETFs

Answer Explanation
Intra-day trading is available for both closed-end funds and ETFs.

Textbook Reference
Please see textbook section 4.6

Question 4

Which two statements correctly compare ETFs and closed-end funds?

I. Both are investment company products
II. Closed-end funds are investment company products; ETFs are not
III. Both have a stable pool of capital
IV. Closed-end funds have a stable pool of capital; ETFs offer shares continuously
A) I and III
B) II and IV
C) II and III
D) I and IV

Answer 4

Correct Answer:
A) I and III

Answer Explanation
Closed-end funds are actually considered a type of ETF by some. These are both classified as closed-end investment companies because they have a stable pool of capital that is raised through their initial public offering.

Textbook Reference
Please see textbook section 4.6

Question 5

Which two of the following are characteristics of closed-end companies and their shares?

I. May be purchased on margin
II. Issue multiple share classes
III. May be purchased with stop or limit orders
IV. Are redeemed by the fund
A) II and IV
B) I and IV
C) II and III
D) I and III

Answer 5

Correct Answer:
D) I and III

Answer Explanation
Closed-end funds are traded on exchanges and may be purchased or sold with specified pricing terms through stop and limit orders. They may be purchased on margin, unlike open end company shares. They issue a single class of shares only, and they are not redeemed by the fund. Shareholders must sell their shares on exchanges to liquidate their positions.

Textbook Reference
Please see textbook section 4.3.2.6

Question 6

The NAV of a mutual fund share will decrease by the amount of the dividend
A) at the start of trading on the morning the dividend is announced.
B) on the ex-dividend date.
C) when announced by the board of directors of the fund.
D) on the payable date.

Answer 6

Correct Answer:
B) on the ex-dividend date

Answer Explanation
The NAV of the fund will decrease on the ex-dividend date.

Textbook Reference
Please see textbook section 4.2.5

Question 7

Money market funds are most appropriate for investors who
A) Are willing to take high degrees of risk.
B) Have no alternative investment choices available to them.
C) Are seeking safety and stability in their investment portfolio.
D) Are looking for tax deferred investments owing to their high tax bracket.

Answer 7

Correct Answer:
C) Are seeking safety and stability in their investment portfolio

Answer Explanation
Money market funds are suitable for investors who are seeking safety and stability in their investment portfolio. These products will often provide a high degree of liquidity.

Textbook Reference
Please see textbook section 4.2.4.2

Question 8

In addition to management companies and face-amount certificates, what is the third basic investment company type regulated under the Investment Company Act of 1940?
A) Private Equity funds
B) REITs
C) Direct participation programs
D) Unit Investment Trusts

Answer 8

Correct Answer:
D) Unit Investment Trusts

Answer Explanation
The three basic types of investment companies that are regulated under the Investment Company Act of 1940 are management companies, face-amount certificates and unit investment trusts.

Textbook Reference
Please see textbook section 4.4

Question 9

An investor purchased shares of a mutual fund two years ago for $3,500 and has since reinvested dividend distributions of $375 and $325. The investor’s total cost basis in this fund is now
A) $700.00
B) $2,800.00
C) $3,500.00
D) $4,200.00

Answer 9

Correct Answer:
D) $4,200.00

Answer Explanation
The investor’s cost basis in this mutual fund is their original purchase price ($3,500) plus the reinvested dividends ($700), for a total of $4,200. This topic is not explicitly covered in the textbook, but as long as you review this rational for this question you will be covered for exam purposes.

Textbook Reference
Please see textbook section 4.2.5.7

Question 10

A customer that purchases closed-end fund shares may pay all of the following EXCEPT
A) Fund expenses
B) Commissions to a sales representative
C) Management Fees
D) 12b-1 fees

Answer 10

Correct Answer:
D) 12b-1 fees

Answer Explanation
Closed-end company shares do not have 12b-1 fees. These are marketing fees incurred by the investor.

Textbook Reference
Please see textbook section 4.3.2.3

Question 11

A risk of investing in an international bond UIT that is not commonly associated with other bond UITs is
A) Reinvestment risk
B) Interest rate volatility
C) Currency risk
D) Liquidity risk

Answer 11

Correct Answer:
C) Currency risk

Answer Explanation
International bond UITs hold debt in foreign companies and governments that is denominated in foreign currencies and then converted into U.S. dollars. The dollar does not always hold strong value against other foreign currencies.

Textbook Reference
Please see textbook section 4.4.3.1

Question 12

A UIT sells units to investors
A) Through representatives of broker dealers with which selling agreements have been established
B) In private placements only
C) Through the trustee that administers the trust
D) Directly through the sponsor

Answer 12

Correct Answer:
A) Through representatives of broker dealers with which selling agreements have been established

Answer Explanation
The units of UITs are typically distributed by the representatives of broker dealers. A broker dealer must have a selling agreement with the UIT to distribute the UIT’s shares through its representatives.

Textbook Reference
Please see textbook section 4.4.2

Question 13

In a unit investment trust the party that is responsible for the trust’s organization is the
A) Trustee
B) Administrator
C) Investment manager
D) Sponsor

Answer 13

Correct Answer:
D) Sponsor

Answer Explanation
A sponsor initiates the formation of a unit investment trust, and is also responsible for the selection of securities that are held in the portfolio.

Textbook Reference
Please see textbook section 4.4.1

Question 14

Which of the following features is associated with mutual fund shares but NOT ETFs?
A) Professionally managed pool of securities
B) Securities held by investors represent an equity interest
C) Exchange traded
D) Continuous primary offering

Answer 14

Correct Answer:
D) Continuous primary offering

Answer Explanation
Mutual fund shares are issued through a continuous primary offering, which means shares are available when investors want to purchase them. Closed-end company shares are limited because there is a fixed pool of capital. ETFs are traded on exchanges, mutual fund are not.

Textbook Reference
Please see textbook section 4.6

Question 15

An individual that invests in a unit investment trust holds
A) An interest in a variable portfolio of securities that is held for a specified period of time
B) An interest in a variable portfolio of securities that will terminate at the discretion of the sponsor
C) A fixed interest in a portfolio that is held for a specified period of time
D) A fixed interest in a portfolio that will terminate at the discretion of the sponsor

Answer 15

Correct Answer:
C) A fixed interest in a portfolio that is held for a specified period of time

Answer Explanation
Investors in UITs purchase a share of a portfolio of securities that will be held until its date of termination which is defined at the inception of the trust.

Textbook Reference
Please see textbook section 4.4.1.2

Question 16

When one of an investor’s goals when purchasing mutual funds is to minimize fees, consideration should be given to
A) Actively managed funds
B) Hedge funds
C) Target date funds
D) Index funds

Answer 16

Correct Answer:
D) Index funds

Answer Explanation
Index funds are appropriate for investors seeking to minimize fees. The other choices will generate more significant fees due to their active management.

Textbook Reference
Please see textbook section 4.2.4.6

Question 17

Which of the following are true about Exchange Traded Funds?
A) They are marginable
B) They are actively managed
C) They can only be purchased as new issues
D) They cannot be sold short

Answer 17

Correct Answer:
A) They are marginable

Answer Explanation
Exchange Traded Funds are a type of exchange traded products mirrors a stock index. They are not actively managed, they are supervised. ETF’s can be sold short; they can be purchased as new issues or on exchanges in the secondary market, and are marginable.

Textbook Reference
Please see textbook section 4.5.1.2

Question 18

With regard to the price of closed-end fund shares held by investors which of the following statements is TRUE?
A) Shares are sold at the price calculated at the close of business on that day
B) Shares may be sold at a discount or premium to their NAV
C) Shares are sold at a discount when the securities in the fund have increased in value relative to their NAV
D) The price is set by formula each business day

Answer 18

Correct Answer:
B) Shares may be sold at a discount or premium to their NAV

Answer Explanation
Closed-end company shares trade in the secondary market on exchanges. Their prices are determined by supply and demand and may be priced at a premium or discount to their NAV.

Textbook Reference
Please see textbook section 4.3.2.2

Question 19

A privilege that applies to mutual fund shareholders and allows them to receive sales charge discounts based on a prior purchase is
A) Conversion privilege
B) A Breakpoint schedule
C) Rights of accumulation
D) Dollar cost averaging

Answer 19

Correct Answer:
C) Rights of accumulation

Answer Explanation
The rights of accumulation privilege allows mutual fund investors to receive breakpoint discounts based on purchases made at a prior time, in different accounts, by other close family members, and for purchase of other funds within the same family. For example, if a mutual fund offers a breakpoint for purchases of $25,000 or more, an investor with shares worth $20,000 could get a reduced sales charge on a $5,000 investment.

Textbook Reference
Please see textbook section 4.2.5.6

Question 20

A mutual fund sponsor receives a request for redemption just after market close and redeems the shares at the NAV just calculated at the close. Which of the following statement is TRUE?
A) Since the order was received after market close, the redemption should have taken place at market opening on the next business day
B) This is standard practice for the redemption of fund shares since redemption must be made on the day of request
C) This is a prohibited practice known as late trading
D) This is a permitted practice known as late trading

Answer 20

Correct Answer:
C) This is a prohibited practice known as late trading

Answer Explanation
This is an example of the prohibited practice of late trading. Mutual fund redemptions are to be made following the forward pricing convention, which means they are to receive the next calculated price. An information advantage may be available if forward pricing is not followed, and a number of large fines have been assessed on firms that engaged in this practice.

Textbook Reference
Please see textbook section 4.2.6

Question 21

Closed-end funds are subject to regulation by which of the following?
I. The Securities Act of 1934
II. The Investment Company Act of 1940
III. The Investment Advisors Act of 1940
A) I and II only
B) II and III only
C) I, II, and III
D) I and III only

Answer 21

Correct Answer:
C) I, II, and III

Answer Explanation
Closed-end companies are subject to regulation under all major securities Acts, including the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisors Act of 1940. The Securities Act of 1933 also applies when the closed-end fund is first issued.

Textbook Reference
Please see textbook section 4.1