Chapter 5: Product Information - Investment Company Securities And Variable Contracts Flashcards
75% of a portfolio, 5% or less of assets into one company, 10% or less of one company’s outstanding voting shares owned
75-5-10 rule
Owns a piece of all the ingredients in the portfolio:
Undivided interest concept
Would keep track of all the dividends and capital gains distributions:
1099-DIV
Investors receive one semi-annual report and one annual report from the fund:
Mutual fund
Grow profits faster than competitors and/or overall stock market, P/E ratio, dividend income would be secondary goal:
Growth fund
Seek out companies valued much less than actually worth, high dividend yields, very conservative:
Value funds
More aggressive than value funds, and less volatile than growth funds, “middle of the road approach”, allows investors to get a diversified investment that can also maximize growth potential:
Blend/core funds
Buy equities that provide dependable income, dividend income is main reason for purchase, receiving dividends reduce the volatility of an investment
Equity income funds
Keeps large percentage of its assets in both the stock and bond markets:
Balanced fund
Invests in companies located anywhere but the US:
International fund
Invests in companies located and doing business anywhere in the world, including the US:
Global funds
Typically no sales charges and low expenses and management fees:
Index funds
Can’t do well during a slump and is considered volatile/high risk:
Specialty fund
If the investor is not in a high tax bracket of investing in an IRA, 401(k), etc., recommend:
Taxable bond funds
If the investor is in a taxable accountant wants to earn interest exempt from federal income tax, recommend:
Tax-exempt bond fund
Buy short-term obligations of states, counties, cities, school districts, etc., pay low rates of interest, should be sold to top marginal tax bracket investors:
Tax-exempt money market funds
Opened to sophisticated, accredited investors, illiquid (at least 1 year), risky strategies, charge high management fee and 20% of gains, private investment partnership (limited):
Hedge funds
Expensive, limits upside of profits made, for conservative investors who need a lump sum at a fixed point in the future, no income for a while, lock-up period (5-10 years), dividends/capital gains must be reinvested, sales charge and operating expenses are high:
Principal-protected funds
Has over $1 million in net worth and makes >$200,000 per year. A married couple, assets held jointly count toward the $1 million, and income needs to be >$300,000:
Accredited investor
Funds that are more rigid in their percentages compared to a balanced fund:
Asset allocation funds
A mutual fund that holds shares in a bunch of other mutual funds, expense ratios tend to be expensive, sales charges may be high:
Funds of funds
Provides information on the party managing the portfolio (investment adviser/portfolio manager):
Prospectus
Not all funds have sales charges or redemption fees, but all funds have expenses:
True
Indicates the administrative efficiency/effectiveness of the fund, may be a tiebreaker when choosing between similar funds:
Expense ratios
Cover distribution expenses and leaves a profit for the underwriter/sponsor/distributor of the fund:
Sales charge
The maximum allowed sales charge:
8.5%
Sales charge, redemption fee:
Shareholder fees
Management fee, 12b-1 fee, custodial fee, transfer agent fee, consulting and legal work, board of directors salaries:
Expenses
Capital appreciation, dividends, capital gains:
Total return
Are not short term investments:
Mutual funds
A mutual fund could be compared to another based on how much interest rate risk they take on (duration), or how aggressive they are in their stock selections (beta):
Quantitative risk measurements
Charge a front end load when the investor acquires them, long-term investor with $50,000+ to invest:
A-shares
Back-end load, percentage declines after second year until gone, converts to A-shares, contingent deferred sales charge, intermediate or long-term investor with small amount to invest, fund takes a higher 12b-1 fee every quarter:
B-shares
Can charge a 12b-1 fee as long as it doesn’t exceed (.25%) of the fund’s assets, can take an amount not exceeding 25 basis points every quarter:
No-load fund
Don’t charge an upfront load but do carry a high 12b-1 fee only charged for two or three years, some charge a contingent deferred sales charge if investor sales in less than 1 1/2 or less, short-term investor with <$500,000 to invest:
C-shares (Level load)
Sales charges and 12b-1 fees cover:
Distribution costs
To calculate the Sales Charge:
POP - NAV
To calculate the sales charge as a percentage:
POP - NAV ÷ POP
To calculate the POP:
NAV ÷ (100% - sales charge)
The more shares you buy, the lower the sales charge:
Breakpoint
A document explaining the intention of investing a certain number of shares over the next 13 months to qualify for a breakpoint, could be backdated up to 90 calendar days, investment clubs don’t qualify:
Letter of intent
To encourage an investor to invest a lower amount of money in order to keep him from obtaining a lower sales charge offered at the next breakpoint:
Breakpoint selling
If an investor’s fund shares appreciate, invests new money or account accumulates up to a breakpoint, the investor will receive a lower sales charge on additional purchases:
Rights of accumulation
May combine fund families to qualify for a breakpoint:
Combination privilege
Allows investors sell shares of a fund in order to buy shares of another in the same family at the NAV, rather than the higher POP, taxable event, all gains or losses are recognized on the date of sale:
Conversion/exchange privilege
If investor reinvests dividends, she can reinvest at the NAV and can:
Avoid sales charges
An official stamp that officers of a bank put on required paperwork. Would be required if redemption is: over $75,000, made payable to someone other than the registered shareholder, or sent to an address other than the address of record, or an address of record that had been changed within the last 10 days:
Signature guarantee
Mutual funds redeem shares within:
7 days
In order to set up, investor must have a minimum account value of $5,000, payments are made first from dividends, then capital gains, and then the fund starts redeeming shares:
Systematic withdrawal plans
Oversees operations of the fund. Responsibilities include: establish investment policy, select and oversee the investment adviser, transfer agent, and custodian; establish dividends and capital gains policy; review and approve 12b-1 plans; does not manage the portfolio, only the company:
Board of directors
They elect and re-elect the board members. They also vote their shares to approve the investment adviser’s contract and 12b-1 fees among other things:
Shareholders
Base their investment decisions on careful research of economic/financial trends, manages the fund’s investments, paid a percentage of the fund’s net assets (fund’s biggest expense), they have to advise the fund in keeping up with federal securities and tax laws:
Investment adviser (portfolio manager)
Responsible for all the cash and securities owned by the mutual fund, receives the dividends and interest payments made by the stocks and bonds in the fund’s portfolio, responsible for the payable/receivable functions involved when the portfolio buys/sells securities
Custodian
Issues new shares to buyers and cancels the shares that sellers redeem. Holds customer securities. Distributes income to the investors. Acts as a customer service rep for the fund. Sends out semi-annual and annual reports.
Transfer agent
Bear the costs of distributing the fund up front and then get compensated by the sales charge that they earn themselves or split with the broker-dealers who make the sales. Prepare the sales literature for the fund.
Underwriters (distributors,wholesalers)
Changes in investment policies and objectives, approval of investment adviser contract, approval of changes in fees, approval of and discontinuation of 12b-1 fees, election of board members, ratification of independent auditors.
Things mutual fund shareholders vote on
Change from open-end to closed-end (vice versa); change from diversified to non diversified (vice versa); borrow money, lend money, purchase real estate or commodities; cease functioning as an investment company.
Things investment companies may not do, unless they get a majority of outstanding voting shares
Continuous offering of unlimited number of shares. Issues one class of stock. Shares are purchased/redeemed with issuer. Min. Net worth of $100,000. At least 100 shareholders. Borrowing is limited (debt ratio is three to one, or 300%). Report to shareholders annually and semi-annually. NAV calculated at least once every business day. No short sales, no margin trading and no uncovered options. Ex-date set by board of directors.
Open-end fund (Mutual fund)
Have an IPO. Fixed offering of shares. Shares may be purchased below NAV. may be purchased on margin or sold short. Issue senior securities. Shares must be traded in the secondary market. Ex-date established by SRO.
Closed-end fund
When purchasing, investor pays installments or a lump sum and later receives the higher face value on the certificate on a future date. Carry sales charges and management fees.
Face-amount certificate
Pooled investments that are not actively managed/traded portfolios, so they don’t charge a management fee. Units are redeemable.
Unit Investment Trusts (UITs)
Trade like shares of stock, intraday; investors pay a commission rather than a sales charge; shares can be bought on margin; sold short; have low expense ratios; are convenient for investors seeking diversification/asset allocation; are very low cost when purchased in larger quantities; trades like an index; Series 6 holders can’t sell them.
Exchange-Traded Funds (ETFs)
(Front-end load) 50% of the investors’ money goes towards buying mutual shares. Sales charge has to average out 9% over the life of the plan. Or, (Spread load) 20% of the investors’ money goes towards buying mutual fund shares. Cannot take more than an average of 16% over any 4-year period. Customer has a free-look period of 45 days, and 60 days to mail the letter. Afterwards, investor can still cancel for up to 18 months and receive some of her money back. Entitled to a prospectus on both the plan company and the mutual fund. Formed as a UIT and, individual is not required to make payments.
Contractual plans
Three main types of annuities:
Fixed, Indexed, and Variable
When you add the management fee, the 12b-1 fee, and other expenses fee, you have:
Expense ratio
Promises a minimum rate of return to the investor. Purchase payments are allocated to the insurance company’s own general account. Suitable for someone who wants a “safe money” investment.
Fixed annuity
Investor receives a guaranteed minimum higher rate of return. Has a participation rate. Has a cap in place.
Equity indexed annuity
Apply to both Fixed and Variable annuities. Has a surrender period and a surrender charge (Contingent Deferred Sales Charge). For investors without high liquid needs. Early withdrawals subject to 10% penalty tax (if under age 59 1/2).
Deferred annuity
Doesn’t promise a rate of return. Invests in subaccounts. Annuitant bears investment risk. Death benefit in effect while the annuitant is deferring any payment from the contract.
Variable annuities
Come with a mortality guarantee, tax deferral, death benefit (at least the principal invested), surrender period and surrender charge, many will allow an annual 10% withdrawal of the contract value, mortality & expense risk fee. May start receiving payments after age 59 1/2. Adds 1-1.5% per year in expenses to the investor. When choosing a payout option, investor cannot change his decision. Can’t be turned into a life policy.
Annuity
When the individual purchases the annuity, the following are deducted from the check:
Sales charge (if they have a front-end load), administrative fee, state premium tax
The company may offer to enhance the buyer’s premium by contributing an additional 1 to 5% of what investor puts in. Fees are attached. Surrender period is longer. Disappears if investor surrenders the contract early.
Bonus annuities
Three methods of purchasing annuities:
Single-Payment Deferred Annuity, Periodic-Payment Deferred Annuity, Single-Payment Immediate Annuity
The largest monthly payout. Makes payments for as long as he lives, afterwards, company keeps the account balance.
Life only (straight life)
Individual is guaranteed a certain number of payments. If he dies before receiving them, his beneficiary receives the balance of payments.
Unit refund life annuity.
Makes payments for a certain period of time (even after annuitant dies). Low monthly payments. Annuitant may choose a beneficiary.
Period certain
The company will make payments for the rest of his life or a certain period of time. If annuitant dies before X years, payments go to beneficiary. If annuitant dies after X years, no more payments are made.
Life with period certain
Company makes payments as long as either the annuitant or the survivors are still alive. Would provide the smallest monthly check.
Join with last survivor
Get to vote their units on important decisions such as: Electing the Board of Managers; Changing the investment objectives, Policies; Ratifying the Independent Auditor/Accounting Firm
Variable annuity owners
To calculate the first payment for a variable annuity, the insurance company uses the following:
Age of the annuitant, Account value, Gender, Settlement option
Although the value of annuity units fluctuates in a variable annuity during the payout phase;
the number of annuity units is fixed
If the separate account returns are better than the assumed rate, the units increase in value. If the account returns are exactly as expected, the unit value stays the same. And if the account returns are lower than expected, the unit value drops from the month before.
Assumed Interest Rate (AIR)
This conservative investment account that guarantees the payout on whole life, term life, and fixed annuities:
Genera account
A mutual fund family that offers tax deferral, but we don’t call it a mutual fund, even though it’s also covered by and registered under the same Investment Company Act of 1940:
Separate account
Withdrawals from the IRA annuity account must begin at the age of:
70 1/2
Unlike a loan against a life insurance policy, however, a loan from an annuity is:
Treated as a distribution, so, it’s not tax-free
Exchange a contract for another without paying taxes:
1035 Exchange
When the annuitant begins receiving monthly checks, part of each check is considered taxable ordinary income, and part of it is considered to be part of the cost basis. Once the annuitant has received all of the cost basis back, each additional annuity payment:
Will be fully taxable
An individual taking a series of substantially equal periodic payments. The IRS won’t penalize him for early withdrawals, but aren’t tax-free either. The IRS requires you to continue the program for five years or until you are the age of 59 1/2, whichever comes last.
72(t) or, SEPP program
A variable annuity charges the following fees:
Mortality risk fee, Expense risk fee, Investment management fees
The value of the subaccounts (cash value), and the death benefit are calculated:
Daily, Annually (Respectively)
Variable life policies are funded as:
Scheduled premium
Variable Universal or Universal Variable Life policies are funded as:
Flexible premium
The customer has to maintain enough cash value and death benefit to keep the policy in force. Is funded as flexible premium:
Variable Universal or Universal Variable Life policies
Make 75% of the cash value available to the customer as a loan after three years (charge interest). Flexible schedule (try not to let policy lapse). Free-look period of at least two years (24 months) to switch back to Traditional Whole Life without having to provide insurability. Must be presented primarily as insurance policies.
Variable life policies
Four federal acts are involved with variable life insurance and variable annuities:
- Securities Act of 1933 (Paper Act); 2. Securities Exchange Act of 1934 (Registered Broker-Dealer); 3. Investment Company Act of 1940 (The Separate Account); 4. Investment Advisers Act of 1940 (Investment Adviser)
From highest to lowest volatility:
Growth, growth & income, equity income funds, and balanced funds
