Chapter 7: Investment Companies Flashcards
Types of Investment Companies
1) Closed End: have a fixed initial market capitalization because of a specific number of shares that are initially sold. The shares are then traded on an organized exchange. No new shares are issued. Shares sold at NAV.
2) Open End: have an unlimited number of shares. As long as the open-end fund receives contributions, the fund family will continue to issue shares. They are bought and redeemed directly from the fund family. Shares trade at NAV.
3) Unit Investment Trust: passively managed & are self-liquidating.
Closed vs Open-End Funds vs UIT’s
*All 3 based on NAV
Closed-End: actively managed; issues a fixed number of shares through an IPO to raise capital for its investments
- shares can then trade on Secondary Market but no new shares will be created
- many muni bonds are closed-end
- Usually sold at either a premium or discount to NAV
Open-End: (almost synonymous for MFs)
- usually passively managed; consists of well-diversified portfolio; can issue new shares
- NOT traded on secondary market. Rather, are only traded directly from the company that issues
Unit-Investment Trusts (UITs): an investment company that buys or holds a group of securities and makes them available to investors as redeemable units. Mostly consist of muni bonds.
- NO additions to investments once the trust has been structured
- Passively managed & self-liquidating
- Shares are NOT traded on the open market
Types of Mutual Funds
-Market Capitalization: total value of a company’s shares in the market. Large Cap companies tend to be more mature, are less volatile, and offer slower/steadier growth. Small Cap companies are more volatile, have greater reward potential, and are more affordable per share for investors.
Aggressive Growth: small caps, great risk, great potential for capital appreciation
- Growth: invest in stocks with high P/E ratios, little/no dividends, growing earnings rapidly
- Growth & Income: primary objective is to provide capital appreciation & income
- Value Fund: invests in undervalued funds with low P/E, high dividends, & positive outlook
- Balanced Funds: invests more in bonds
- Bond Fund: invests in liquid bonds, cost effective & conservative
- Money Market Fund: highly liquid, appropriate for emergency fund, securities mature 90 days or less
- Index Funds: passively managed, tracks performance of market indices, have low turnover rates which minimize capital gain distributions
- Sector Funds: invest in sectors of the US economy (ex. healthcare). Not well diversified
- Asset Allocation or Lifecycle Funds: well-diversified portfolios. As market conditions change or as investor gets closer to retirement goal, asset allocation changes
- Global Funds: international AND US securities
- International Funds: invest only in international securities, EXCLUDES US securities
Fund Expenses (Load vs No Load Funds)
1) No Load Funds: do not charge sales commission when purchased or redeemed
2) Load Funds: charge sales commission when purchased or redeemed (ex. A, B, or C shares)
A, B, & C Shares
- A Shares: front-end load (up-front sales commission). Appropriate for LT investors because of low 12b-1 fees (marketing and distribution costs).
- B Shares: back-end sales load (redemption fee). Have high 12b-1 fees. Many do not offer B shares funds.
- C Shares: do not charge a front-end load. Most appropriate for ST investors.
ETF’s
- Portfolio of stocks that represent an index
- Traded on an exchange similar to stocks and can be traded intra-day, unlike traditional mutual funds.
- Passive investments & have no active trading within the fund because the ETF is tracking a stock index.
- Tax efficient because of the low asset turnover and passive investment strategy
Real Estate Investment Trusts (REIT’s)
- Attractive because of the low correlation with the stock market & the diversification.
- Used as a hedge against inflation.
- Must distribute 90% of investment to maintain tax-exempt status. 3 Types - equity, mortgage, and hybrid.
American Depository Receipts (ADR’s)
- Foreign stock held in domestic banks’ foreign branch
**Exam Tip: MUST know that they do not eliminate exchange rate risk.
Options
Options: a derivative security. The value is derived from that of another underlying asset. Two types - call & put.
Cryptocurrency
CFP professional is not prohibited but is not required to provide Financial Advice on crypto-related assets.
