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SS Own Cards > Lesson 7 of Investments: Investment Companies > Flashcards

Lesson 7 of Investments: Investment Companies Flashcards

1
Q

Types of Investment Companies!

A
  • Closed End
  • Open End
  • Unit Investment Trust (UIT)
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2
Q

Closed End

A
  • Fixed Initial market capitalization.
  • Shares trade on an organized exchange.
  • May trade at a
    • premium or
    • discount
    • to NAV.
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3
Q

Open End

A
  • Unlimited market capitalization as long as
    • family receives contributions.
  • Shares are bought and redeemed directly
    • from fund family.
  • Shares trade at Net Asset Value (NAV).
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4
Q

NAV Formula

Not given on exam

A

(Assets - Liabilities) ÷ Shares Outstanding

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5
Q

Unit Investment Trust (UIT)

A
  • **Can be **
    • equity or
    • fixed income unit investment trust.
  • Typically fixed income trust.
  • Managed by a Trustee,
    • there is no investment manager.
  • Unit investment trusts are self liquidating, have passive management and
    • no trading of assets within the trust.
  • A unit investment trust issues
    • “units” not shares.
  • Units can be sold back to the UIT at NAV (net asset value).
    • There is a very thinly traded secondary market.
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6
Q

Exam Tip

A

Know that UITs are

  • passively managed
    and
  • self liquidating.
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7
Q

Types of Mutual Funds!

A
  • Aggresive Growth
  • Growth and Income
  • Value Fund
  • Balance Fund
  • Bond Fund
  • Money Market Fund
  • Index Fund
  • Sector Fund
  • Asset Allocation Funds or Lifecycle Funds
  • Global Funds
  • International Funds
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8
Q

Aggressive Growth

A
  • Invests in small caps and
  • offers the greatest potential
  • for capital appreciation.
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9
Q

Growth

NEED TO KNOW THIS ONE

A

Invests in equities

  • that have a high P/E,
  • little to no dividends and
  • are growing earnings and revenue rapidly.

Objective is to generate capital appreciation.

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10
Q

Growth and Income

NEED TO KNOW THIS ONE

A

Invests in

  • equities and
  • income-producing assets.

Primary objective is to provide capital appreciation and income.

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11
Q

Value Fund

A

Invests in undervalued funds that have a low P/E, high dividend yields and positive future outlook.

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12
Q

Balanced Fund

NEED TO KOW THIS ONE

A

Invests in

  • more bonds than a typical equity fund.

Seeks a well-balanced return

  • in the form of both
    • income and
    • capital appreciation.
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13
Q

Bond Fund

A

Provides investors with a liquid bond investment that is cost effective and fairly conservative.

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14
Q

Money Market Fund

A

Highly liquid, appropriate for an emergency fund and invests in securities with maturities of less than 90 days.

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15
Q

Index Fund

NEED TO KNOW THIS ONE

A

Tracks the performance of various market indices.

  • Index funds are a passive investment strategy that are tax efficient.
  • Index funds have low turnover rate which minimizes capital gains distributions.

Also called Stock Index Fund

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16
Q

Sector Fund

A

Invest in sectors of the US economy such as telecommunications, healthcare, financial services, etc. Sector funds are not well-diversified and have a low -squared (0.50-0.60).

17
Q

Asset Allocation Funds or Lifecycle Funds:

A

Are well-diversified portfolios including

  • stock,
  • fixed income,
  • international and
  • money market securities.

As market conditions change or as the investor gets closer to her retirement goal,

  • the asset allocation changes.
18
Q

Global Funds

NEED TO KNOW THIS ONE

A

Invests in international and US securities.

19
Q

International Securities

DO NOT NEED TO KNOW THIS ONE

A

Invests only in international securities and excludes US securities.

20
Q

Exam Tip

A

May be given client facts and asked to recommend a portfolio of mutual funds. Always recommend the most diversified portfolio of funds (all else being equal).

21
Q

Exam Question

A client has a growth objective but requires a large percentage of the return to be tax-efficient. which of the following products would be most appropriate for this client? (CFP® Certification Examination, released 2004)

a) Non-leveraged equipment leasing.
b) Balanced mutual fund.
c) Preferred stock mutual fund
d) Stock index fund.

A

Answer: D
Stock index funds are tax efficient because they have a low turnover ratio. Stocks are not frequently added or removed from an index, which leads to low turnover and infrequent capital gains distributions.

22
Q

Fund Expenses!

A
  • No Load Funds
  • Load Funds
  • A Shares
  • B Shares
  • C Shares
23
Q

No Load Funds

A

Do NOT charge a sales commission

  • when purchased or redeemed.
24
Q

Load Funds

A
  • Load funds charge a sales commission when purchased or redeemed.

Examples of load funds include

  • A shares, B shares and C shares which are discussed below.
25
Q

A Shares

A
  • A shares have a front-end load (up front sales commission).
  • Small 12b-1 fee, which is the marketing fee used to pay distribution expenses (known better as “trailing commissions”).
  • No redemption fee or back-end load.
  • A shares are appropriate for long-term investors
    • because of the low 12b-1 fee.
26
Q

B Shares

A
  • B shares contain a back-end sales load(redemption fee.)

They also have high 126-1 fee, typically the maximum 12b-1 fee of 1%.

  • NO front-end sales load.
  • B shares can be converted to A shares.
    • The only advantage is that an investor would not pay the front-end load, but they would pay the higher 12b-1 fee until the shares are converted into A shares.
  • Many funds no longer offer B shares.
27
Q

C Shares

A
  • C shares do NOT charge a front-end load.
  • C shares usually charge a small back-end load and
  • charge the maximum 12-1 fee of 1%.
  • C shares are usually most appropriate for short-term investors.

C shares do NOT convert to A shares.

28
Q

Exchange Traded Funds (ETFs)!

A
  • ETFs are a portfolio of stocks that represent an index.
  • ETFs are traded on an exchange similar to stocks and can be traded intra-day, unlike traditional mutual funds.
  • Investors do not have to buy and sell blindly.
  • ETFs have a low cost of ownership because they are typically passive investments. Most ETFs have no active trading within the fund because the ETF is tracking a stock index. Only when stocks are added or removed from an index is there actually selling of assets within an ETF.

Most ETFs are tax efficient investments because of the low asset turnover and passive investment strategy.

  • Examples include:
    • QQQQ -> NASDAQ 100
    • SPY -> S&P 500

ETFs are structured to track an index, but they can also be actively managed to track an investment manager’s top picks, or mimic an existing mutual fund.

This is less likely to be tested on the exam.

29
Q

Real Estate Investment Trusts (REITs)!

A
  • REITs are attractive because of the low correlation with the stock market and the diversification benefit that they provide to portfolios.
  • Similar to a closed end mutual fund.
  • Real estate is a hedge against inflation.
  • REITs must distribute 90% of investment income to shareholders to maintain tax-exempt status

There are three types of REITs:

  1. Equity.
  • Invest in real estate for capital appreciation.
  • Income is generated from rental income and appreciation.
  1. Mortgage.
  • Invest mostly in mortgages and construction loans.
  • Make the spread between the lending and borrowing rate.
  1. Hybrid.
  • Combo of both equity and mortgage.
30
Q

American Depository Receipts (ADR)

A

ADRs represent foreign stock held in domestic banks’ foreign branch.

  • ADRs entitle the shareholder to dividends and capital gains.
    • Capital gains in ADRs include currency fluctuation.
  • ADRs trade on US exchanges, are
    • denominated in US dollars and
    • trade in US dollars.

Dividends are paid in US dollars.

ADRs do not eliminate exchange rate risk.

VERY IMPORTANT: THEY DO NOT ELIMINATE EXCHANGE RATE RISK

31
Q

Exam Tip

A

Must know that ADR do not eliminate exchange risk.

32
Q

Exam Question

American depository receipts (ADRs) are used to: (CFP@ Certification Examination, released
3/95)
1. Finance foreign exports.
2. Eliminate currency risk.
3. Sell US securities in overseas markets.
4. Trade foreign securities in US markets.
a) 1 and 3
b) 1and 4
c) 2 and 4
d) 4 only.
e) 1, 2, and 4

A

Answer: D

Answer C is tempting, but not correct. ADRs trade in US dollars on the US markets, but the actual foreign shares are held in a domestic bank’s foreign branch and the exchange of currency happens there, so currency risk is still relevant.

33
Q

Alternative Investments!

A
  • Common Characteristics
  • Most Common Alternative investments
34
Q

Common Characteristics

A
  • Not for the average investor.
    • Typically high-risk investments with
    • Large minimum purchase requirements and high fees.
  • Actively managed,
    • may use leverage to enhance their returns, and
    • invest in illiquid assets.
  • Liquidity may be limited or nonexistent.
    • There is no secondary market but
    • it may offer redemptions at periodic times with advance notice.
35
Q

Most Common Alternative Investments

A
  • Real estate, REITs. CMOs, Limited Partnerships (addressed other areas in the reading).

Other alternative investments and highlights:

  • Hedge funds-No regulations, self-report, seek positive performance, available to accredited investors only.
  • Collectibles- Fine art, antiques, baseball cards. High risk of fraud, subject to demand and consumer tastes. Net long-term gains from sales of collectibles are subject to a federal income tax rate of 28%.
  • Precious metals -Gold, or silver can be purchased directly, through exchange-traded funds, or futures contracts. Often considered inflation hedges.
  • Cryptocurrency :
    • Virtual currency not assoicated with any country or central bank.
    • Number of “coins” are limited”
    • Not widely accepted as a form of payment.
    • Considered a high-risk investment.
36
Q

Crypocurrency’s Suitability
(CFP Board Notice to CFP Professionals)

A

Can be speculative and volatile investments, and this volatility can have a particularly negative effect on investors;

Are difficult to analyze and present challenges to CFP professionals seeking to make informed investment decisions (with even knowledgeable investors experiencing difficulty evaluating these assets and separating “facts from the hype”);

May present unique custodial risks that expose investors to heightened risk of theft or loss

Raise valuation issues because they may not be subject to commonly-accepted valuation methodologies and may not be subject to consistent accounting treatment or traditional reporting requirements:

May be unregistered or otherwise offered by or through providers who are operating outside of or not complying with existing regulatory frameworks; and

May be subject to additional regulation, which may evolve in unpredictable ways.

SS Own Cards (35 decks)

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