Chapter 7 - Investment Companies

Question 1

• an issuer in the business of investing, reinvesting, owning, holding, or trading in securities
• falls into three classifications: management companies, unit investment trusts, and face-amount certificates
• structured as either corporations or trusts in which investors are able to pool their funds for increased diversification and professional management.

Answer 1

Investment Company

Question 2

• legislation that established guidelines for the operations of investment companies and divided them into 3 types (UITs, Face Amount Certificate, Management Companies)

Answer 2

Investment Company Act of 1940

Question 3

• legislation that requires investment companies to be registered with the SEC.

Answer 3

Securities Act of 1933

Question 4

• classification of an investment company that is established as a trust and operates as a holding company for the portfolio.
• shares are redeemable which means there is no secondary trading and the units must be redeemed by the issuer.
• features a fixed portfolio that is typically held for the life of the trust. The portfolio is “supervised” instead of actively managed.
• at maturity, proceeds are distributed to the investors on a per unit basis.

Answer 4

Unit Investment Trust

Question 5

• classification of an investment company that issues debt certificates that offer predetermined interest rates.
• required to have a maturity of at least 24 months.
• rarely issued today due to changes in tax laws that make them less attractive than other investments.

Answer 5

Face Amount Certificate

Question 6

• classification of an investment company that employs an investment adviser to manage a portfolio of securities to achieve specified investment objectives.
• organized as either open-end or closed-end.

Answer 6

Management Companies

Question 7

• classification of a management company.
• usually capitalized through a one-time public offering of a fixed number of shares.
• After the initial public offering, the shares trade in the secondary market.
• The share price in the secondary market is determined by investor demand.
• Trading in shares may take place on an exchange or in the OTC market.
• Do not redeem shares held by investors.

Answer 7

Closed-End Management Company

Question 8

• also known as a mutual fund. This type of management company provides a continual offering and redemption of shares.
• shares are purchased at POP, which equals NAV + sales charges.
• mutual funds sell ex-dividend on the date determined by the board of directors. The current value of the fund share drops by the dividend distribution on the ex-dividend day.

Answer 8

Open-End Management Company

Question 9

• a prohibited practice of stocks and mutual funds that occurs when investors are encouraged to purchase shares just prior to a dividend distribution for the sole purpose of receiving the dividend

Answer 9

Selling Dividends

Question 10

• this type of mutual fund holds no fixed-income securities, but contains a mix of growth and value stock.

Answer 10

Blended Fund

Question 11

• this type of mutual fund provides a combination of fixed-income instruments and equities.

Answer 11

Balanced Fund

Question 12

• this is a type of investment style of positioning assets over the various asset classes, such as stocks, bonds, and cash equivalents.
• this reduces overall market risk and can reduce the costs associated with diversification.

Answer 12

Asset Allocation

Question 13

• this is a type of mutual fund that invests primarily in securities issued by agencies such as Ginnie Mae (GNMA), Freddie Mac, and Fannie Mae, or possibly private corporations.
• pays a monthly dividend to is shareholders.

Answer 13

Mortgage-Backed Security

Question 14

• this is a type of mutual fund that invests in illiquid assets, such as commercial property and private equity.
• shareholders do not have the ability to redeem shares on a daily basis.
• the issuer periodically offers to repurchase shares from the shareholders; however, this offer does not have to be accepted.
• this type of fund allows investors to invest in large properties and other investments that would not ordinarily be available to individuals.

Answer 14

Interval Fund

Question 15

• employed by the funds board of directors to manage the fund’s portfolio.
• paid a fee (operating expense of the fund) for advisory services that is typically based on a percentage of the net asset value under management.

Answer 15

Investment Adviser

Question 16

• financial institution that holds customers’ securities for safekeeping, providing administrative and operational support.
• this institution must safeguard the physical assets of the mutual fund, perform payable and receivable functions of securities transactions, and register the receipt of interest and dividends for the fund.
• does not perform any management, supervisory, or investment functions; nor does it have any involvement in the sale of shares.

Answer 16

Custodian

Question 17

• contracted by the fund to perform basic clerical functions such as:
  1. Issuance of physical shares or book entry
  2. Cancellation of redeemed shares
  3. Disbursement of dividend and capital gains distributions to shareholders.

Answer 17

Transfer Agent

Question 18

• this expresses the expenses of a mutual fund. It is calculated by dividing the total expenses by average net assets (which is assets minus expenses) of the portfolio.
• the sales charge or load is not included in this calculation.

Answer 18

Expense Ratio

Question 19

• the mutual fund’s sponsor, or distributor. Also called the wholesaler since it “wholesales” shares to dealers.
• has an exclusive agreement with the fund that allows it to purchase fund shares at the current NAV. Shares are then sold to the public, through either outside dealers or the wholesaler’s sales force at POP.
• markets the fund’s shares to dealers that sell the shares to the public.

Answer 19

Underwriter