Investment Vehicles

Question 1

ETPs

Answer 1

Exchange Traded Product

Includes ETF (Fund)s and ETN (Note)s

Trades intra-day
usually lower fees/expenses
commonly passive strategy
tracks an index
accessible

Question 2

ETFs

Answer 2

Description
* a security that trades on an exchange
* shares may be bought and sold throughout the
day
* commonly, passive strategies that track an index
* allows smaller investors access to professional
money managers
Application
* usually lower annual fees and expenses (vs.
mutual funds)

• Potential advantages:
  – Trade continuously like stocks
  – ***Can be sold short or purchased on margin
  – Lower costs
  – Tax efficient
• Potential disadvantages:
  – Prices can depart by small amounts from NAV
  – Must be purchased from a broker

in most cases the ETF itself does not create significant taxable gains/losses that
are passed through to the shareholders. The shareholders however are taxed when
they sell their shares if a capital gain is captured (just like with mutual funds).

Question 3

ETNs

Answer 3

• ETNs are traded on a major exchange
• unsecured debt securities
• can be sold short or purchased on margin
• no coupon payments
• ETNs have a maturity date
• Taxation
  – Typically, more efficient than mutual funds and ETFs
  – Typically, no internal taxation generated for shareholders
  – Shareholders typically only pay taxes if/when recognizing
  a gain upon sale of their shares

Question 4

NAV

Answer 4

Net Asset Value
Calculation:
Market Value of Assets - Liabilities /
Shares Outstanding

Question 5

Open-End vs. Closed-End

Answer 5

Open-End
* Fund issues new shares when
investors buy in and redeems
shares when investors cash out
* Priced at Net Asset Value (NAV)

Closed-End
* no change in shares outstanding; old
investors cash out by selling to new
investors
* Priced at premium or discount to NAV

Question 6

Fees and Mutual Fund Returns: an example

Initial NAV = $20
Income distributions of $.15
Capital gain distributions of $.05
Ending NAV = $20.10

What is the ROR?

Answer 6

ROR = [NAV1 - NAV0 + Income + Cap Gain Distribs] / NAV0

= 20.10-20 + .15 + .05 / 20

= 1.5%

Question 7

SMAs

Answer 7

Can invest in REITs
actively managed
benefit of ind cost basis
less popular now

Question 8

UITs

Answer 8

Unit Investment Trusts
- fixed unmanaged portfolio of stocks/bonds
- more popular w retirees seeking income
- more susceptible to inflation bc int rates are fixed
- more likely to be bond portfolio

Question 9

REITs

Answer 9

Description
* may be public (trades on exchange) or private
* considered a form of UIT
* invests in real estate directly
* must distribute 90%+ of income to shareholders
* receives special tax treatment
* offers diversification, professional management, higher yields, tax
advantages, liquidity
Application
* equity REITs
* mortgage REITs
* hybrid REITs

Question 10

REIT Taxation on Entity

Answer 10

Rental income is treated as business income to
REITs (applies to expenses)
* Income distributions to shareholders is not taxed
to the REIT (tax liability is passed thru)
* Exempt from tax at the trust level if they meet
requirements including 90% distribution rule
* REITs still face corporate tax on retained
earnings and income

Question 11

REIT Taxation – to Unitholders (ShareHolders)

Answer 11

• Dividends paid are taxed as ordinary income unless considered “qualified dividends” which are taxed as capital gains
• Dividends may be considered “return of
  capital” in which case they reduce cost basis and are not considered taxable income

Question 12

Fixed v Variable Annuity

Answer 12

Fixed Annuity – guarantees a stream of payments
over a specified period of time; investment risk
borne by insurance company

Variable Annuity – offer tax-deferred growth to
investors with option of different investments
(through sub-accounts); offers some degree of
asset protection
© Dobbs Education, LLC 31

Question 13

Taxation of Variable Annuities

Answer 13

• Growth is tax-deferred
• Withdrawals before age 59.5 incur 10% penalty
• Gains distributions are taxed as ordinary income

“like” IRAs

Question 14

Which of the following investments is typically not traded by marking to market throughout a typical trading day?

stocks
mutual funds
options
exchange trade funds

Answer 14

Mutual Funds

Open-ended mutual fund shares are typically settled (marked to market) at the end of each trading day.

Question 15

Big Money mutual fund had year-end assets of $862,000,000 and liabilities of $12,000,000. There were 32,675,254 shares in the fund at year-end. What was this mutual fund’s NAV?

Answer 15

(862,000,000 - 12,000,000)/32,675,254 = $26.01

Question 16

An investment vehicle in which taxes are paid only by the investor, investors do not control the timing of sales of securities in the portfolio, and shares are traded at NAV is:

closed-end mutual fund
SMA
open-end mutual fund
REIT

Answer 16

open-end mutual fund

Question 17

Investors in closed-end funds who wish to liquidate their positions must:

hold their shares to maturity.
sell their shares to the issuer for Net Asset Value.
sell their shares through a broker.
sell their shares to the issuer at a discount or premium to Net Asset Value.

Answer 17

sell their shares through a broker

Closed-end fund shares are sold on organized exchanges through a broker.

Question 18

Which of the following statements about Real Estate Investment Trusts is true?

a. REITs invest in real estate or loans secured by real estate and raise capital by borrowing from banks and issuing mortgages.
b. REITs raise capital by borrowing from banks and issuing mortgages.
c. REITs are similar to open-end funds, with shares redeemable at NAV.
d. REITs invest in real estate or loans secured by real estate.

Answer 18

a. REITs invest in real estate or loans secured by real estate and raise capital by borrowing from banks and issuing mortgages.

CIMA Section II.A. Investment Vehicles

Real Estate Investment Trusts invest in real estate or real-estate-secured loans. They may raise capital from banks and by issuing mortgages. They are similar to closed-end funds and shares are typically exchange traded.

Question 19

Which of the following is not accurate or true about REIT taxation?

Rental income is treated as business income to REITs.
REITs do not face corporate tax on retained earnings and income.
Income distributions to shareholders are not taxed to the REIT (tax liability is passed through).
Exempt from tax at the trust level if they meet requirements including the 90% distribution rule.

Answer 19

REITs do not face corporate tax on retained earnings and income.

Question 20

The following attributes and characteristics: publicly traded; entity where 90% of cash flow must come from real estate, commodities or natural resources; and taxation is passed through to unitholders upon distribution – all describe:

Real Estate Investment Trusts
Exchange Traded Funds
Unit Investment Trusts
Master Limited Partnerships

Answer 20

MLPs

Question 21

You invested in the Sacred Poodle mutual fund 7 years ago. The fund did very well, returning an average annual return of 11.1% gross of fees and expenses. Which of the following share choices below would have returned the highest amount to you (the investor) if you held the fund shares the entire 7 years?

Z-shares with no sales charges and annual operating expenses of 0.40, and you paid an investment advisor 0.75% annually to manage the account
A-shares with an up-front sales charge of 3.5% and annual operating expenses of 0.45%
B-shares with no up-front sales charge, annual operating expenses of .75% and with a 12 b-1 charge of 0.50% annually
C-shares with no up-front sales charge, a back-end sales charge of 2% within the first 5 years, and annual operating expenses of 1.35%

Answer 21

A-shares with an up-front sales charge of 3.5% and annual operating expenses of 0.45%

How? Assume a hypothetical lump-sum investment of $1,000.

A-shares = ($1,000 x (1 – 3.5%) = $965. PV = 965, i = 10.65 (11.1 – 0.45), N = 7. FV = $1,960

B-shares = PV = $1,000, i = 9.85 (11.1 - 0.75 – 0.50), N = 7. FV = $1,930

C-shares = PV = $1,000, i = 9.75 (11.1 – 1.35), N = 7. FV = $1,918

Z-shares = PV = $1,000, i = 9.95 (11.1 – 1.15), N = 7. FV = $1,942

Question 22

Which of the following is not accurate or true regarding Exchange Traded Notes (ETNs)?

ETNs pay interest and a cash payment at maturity linked to performance.
ETNs are not rated.
ETNs do not offer voting rights.
ETNs are backed solely by the credit of the issuer

Answer 22

ETNs pay interest and a cash payment at maturity linked to performance.

CIMA Section II.A. Investment Vehicles

Most ETNs do not pay interest; rather they pay a cash payment at maturity that is linked to the performance of the underlying benchmark or index.

Question 23

Which of the following statements about mutual funds is/are incorrect?

I. Mutual funds may be considered pass-through entities for tax purposes.

II. Income plus capital gains distributions plus appreciation divided by the fund’s initial net asset value (NAV) equals the rate of return on a mutual fund.

III. Open-ended funds are priced at a premium or discount to NAV.

IV. Closed-end funds issue new shares when investors buy in and redeem shares when investors cash out.

III and IV only
II, III, and IV only
I and III only
IV only

Answer 23

III and IV only

Mutual funds may be considered pass-through entities for tax purposes. Income plus capital gains distributions plus appreciation divided by the fund’s initial net asset value (NAV) equals the rate of return on a mutual fund. Closed-end funds are priced at a premium or discount to NAV. Open-ended funds issue new shares when investors buy in and redeem shares when investors cash out.

Question 24

Which of the following statements are incorrect about American Depository Receipts (ADRs)?

I. represent shares of ownership in a foreign stock traded on a U.S. exchange
II. do not eliminate currency risk of underlying shares in another country
III. denominated in foreign currency
IV. negotiable certificate or note issued by local foreign bank

III and IV only
IV and II only
II and I only
I and III only

Answer 24

III and IV only

ADRs are denominated in U.S. dollars. ADRs are negotiable certificates or notes issued by a U.S. bank. ADRs represent shares of ownership in a foreign stock traded on a US exchange. ADRs do not eliminate currency risk of underlying shares in another country.

Question 25

Which of the following statements about the taxation of Real Estate Investment Trusts (REITs) is not accurate?

REITs are taxed first at the trust level and then to beneficiaries.
Income is essentially tax exempt to REITs at the trust level if they distribute at least 90% of income to unit-holder.
REITs must generally follow the same rules as Unit Investment Trusts (UITs) but must follow the same method of self-assessment as partnerships.
Rental income and expenses are treated as business income and expenses.

Answer 25

REITs must generally follow the same rules as Unit Investment Trusts (UITs) but must follow the same method of self-assessment as partnerships.

REITs must generally follow the same rules as Unit Investment Trusts (UITs) but must follow the same method of self-assessment as corporations.

Question 26

The process of marking-to-market:

I. posts gains or losses to each account daily.
II. may result in margin calls.
III. impacts only long positions and futures contracts.
IV. increases liquidity but decreases transparency.

IV and I only
I and II only
III and IV only
II and III only

Answer 26

I and II only

Marking-to-market typically involves posting prices on no less than a daily basis.

Marking-to-market effectively puts futures contracts on a “pay as you go” basis.

Question 27

Investors’ Choice Fund had NAV per share of $37.25 on January 1, 2009. On December 31 of the same year the fund’s rate of return for the year was 17.3%. Income distributions were $1.14, and the fund had capital gain distributions of $1.35. Without considering taxes and transactions costs, what ending NAV would you calculate for Investors’ Choice?

Answer 27

.173 = (P - $37.25 + 1.14 + 1.35)/$37.25; P = $41.20

Question 28

Which of the following characteristics apply to unit investment trusts?

I. Most are invested in fixed-income portfolios.
II. They are actively managed portfolios.
III. The sponsor pools securities, then sells public shares in the trust.
IV. The portfolio is fixed for the life of the fund.

I and IV only
I, II, and III only
I and II only
I, III, and IV only

Answer 28

I, III, and IV only

Three chief characteristics of UITs are that:

(1) the sponsor pools securities and then sells public shares in the trust,

(2) the portfolio is fixed for the life of the fund, and

(3) most are invested in fixed-income portfolios.

Question 29

Which of the following statements about Exchange Traded Notes (ETNs) is not true?

ETNs are secured debt securities.
ETNs do not have coupon payments.
ETNs have a maturity date.
ETNs are traded on a major exchange.

Answer 29

ETNs are secured debt securities

Exchange Traded Notes (ETNs): senior, unsubordinated and unsecured debts. Many investors (and advisors) were surprised when brokerage firms were not willing or able to make full payments on ETNs during the financial crises.

Question 30

A 5.5% 20-year municipal bond is currently priced to yield 7.2%. For a taxpayer in the 33% marginal tax bracket, this bond would offer an equivalent taxable yield of:

Answer 30

0.072 / r(1 - t);
0.072 / r(1 - .33);
r = 0.072/0.67;
r = 0.1075;
r = 10.75%

Question 31

The following characteristics below describe which of the following investment structures?

+ trades on an exchange and is priced throughout the day

+ can be sold short or purchased on margin

+ includes more passive strategies but more active strategies are becoming available

+ typically offers lower expenses and better tax management vs. mutual funds

Answer 31

Exchange Traded Funds

a security that trades on an exchange
shares may be bought and sold throughout the day
commonly, passive strategies that track an index
allows smaller investors access to professional money managers
usually lower annual fees and expenses (vs. mutual funds)
examples: “spiders”, “diamonds” and “cubes”
potential disadvantages:
prices can depart by small amounts from NAV
must be purchased from a broker

Question 32

_____________ managers reduce or eliminate internal taxation by buying and selling “units of investment exposure”, thus not creating a taxable gain within the fund that would otherwise have to be passed through to shareholders (like is the case for mutual funds). Thus, in most cases the _______ itself does not create significant taxable gains/losses that are passed through to the shareholders. The shareholders however are taxed when they sell their shares if a capital gain is captured (just like with mutual funds). This investment structure offers market-to-market pricing and does not typically invest in real assets.

Answer 32

Exchange Traded Funds

Investing in ETFs is typically more tax-efficient than investing in comparable mutual funds. Of course, it all depends on the specific ETF and mutual fund.

ETF managers reduce or eliminate internal taxation by buying and selling “units of investment exposure”, thus not creating a taxable gain within the fund that would otherwise have to be passed through to shareholders (like is the case for mutual funds).

Thus, in most cases the ETF itself does not create significant taxable gains/losses that are passed through to the shareholders. The shareholders however are taxed when they sell their shares if a capital gain is captured (just like with mutual funds).

The taxation of dividends received from holding ETF shares is comparable to the treatment of dividends received from holding mutual fund shares. Taxable dividends are treated based on holding period and subject to either ordinary income rates or long-term capital gains (i.e., holding period largely determines whether the dividend is “qualified” for cap gains treatment or is treated as ordinary income for tax purposes).