Management Companies Flashcards
Dollar cost averaging will result in a lower average per share price only if:
I the price of the stock remains fixed
II the price of the stock fluctuates
III a fixed dollar amount is invested periodically
IV a varied dollar amount is invested periodically
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
Dollar cost averaging requires that an investor make periodic payments (say monthly) of a fixed dollar amount (say $100 per month) to buy a given security. If the price of the security is fluctuating, the average purchase cost per share will be lower for the investor than the simple mathematical average price of the shares over the same period. Dollar cost averaging does not work if the price of the stock remains fixed, nor does it protect against loss in a falling market.
Regularly scheduled investments of the same dollar amount in fund shares will most likely result in a:
A. lower average price per share
B. higher average price per share
C. lower average return on investment
D. higher average return on investment
The best answer is A.
Dollar cost averaging results in slightly more shares being bought as prices fall than when prices rise. Thus, if the market is fluctuating fairly evenly, periodic investments of the same dollar amount result in a lower average cost per share. This will not work if the market moves straight up or straight down.
An individual wishes to have a fixed portion of the portfolio liquidated each month. He or she should elect which type of withdrawal plan?
A. Fixed shares
B. Fixed period
C. Fixed percentage
D. Fixed dollar
The best answer is C.
If an individual wishes to redeem shares of a mutual fund under a “systematic withdrawal plan,” he or she gets to elect a withdrawal option. He or she could elect to have a fixed number of shares liquidated each month (Choice A); could elect to have the account liquidated over a specified period of time (for college education) (Choice B); could elect to have a fixed percentage of the portfolio liquidated each month (Choice C); or could elect to have enough shares liquidated so that a specific dollar amount is received each month (Choice D). In this example, Choice C meets the customer’s requirements.
An individual wishes to have a complete liquidation of the account done over a 5 year time frame. He or she should elect which type of withdrawal plan?
A. Fixed shares
B. Fixed period
C. Fixed percentage
D. Fixed dollar
The best answer is B.
If an individual wishes to redeem shares of a mutual fund under a “systematic withdrawal plan,” he or she gets to elect a withdrawal option. He or she could elect to have a fixed number of shares liquidated each month (Choice A); could elect to have the account liquidated over a specified period of time (for college education) (Choice B); could elect to have a fixed percentage of the portfolio liquidated each month (Choice C); or could elect to have enough shares liquidated so that a specific dollar amount is received each month (Choice D). In this example, Choice B meets the customer’s requirements.
A customer redeems 1,000 shares of ABC Fund on Wednesday, June 14th. Under the provisions of the Investment Company Act of 1940, the customer must be paid the money no later than:
A. Thursday, June 15
B. Friday, June 16
C. Monday, June 19th
D. Wednesday, June 21st
The best answer is D.
Under the Investment Company Act of 1940, customers who redeem must be paid within 7 calendar days (1 business week) of the redemption date. Note that most funds process redemptions much more quickly than this.
A customer redeems 1,000 shares of ABC Fund. The customer must be paid the money within:
A. 1 day
B. 3 days
C. 7 days
D. 10 days
The best answer is C.
Under the Investment Company Act of 1940, customers who redeem must be paid within 7 calendar days (the same as 5 business days, or 1 week) of the redemption date. Note that most funds process redemptions much more quickly than this.
Quotes published in the news media for mutual funds show:
A. Bid price at NAV; Ask price at NAV plus an average sales charge
B. Bid price at NAV; Ask price at NAV plus the maximum sales charge
C. Bid price at NAV less any redemption fee; Ask price at NAV plus an average sales charge
D. Bid price at NAV less any redemption fee; Ask price at NAV plus the maximum sales charge
The best answer is B.
News media quotes for mutual fund shares show the Bid Price at Net Asset Value. The Ask Price is Net Asset Value plus the maximum sales charge imposed by that fund.
Quotes published in the news media for mutual funds show:
I Bid price at NAV less any redemption fee
II Bid price at NAV
III Ask price at NAV plus minimum sales charge
IV Ask price at NAV plus maximum sales charge
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
News media quotes for mutual fund shares show the Bid Price at Net Asset Value. The Ask Price is Net Asset Value plus the maximum sales charge imposed by that fund.
Which of the following is a fair comparison of two mutual funds?
A. Income funds and growth funds should be compared based on yield per share after tax
B. A comparison of two income funds should use a ten-year period for one and a five-year period for the other
C. A comparison of two growth funds should use total initial investment, disregarding sales charges
D. A comparison of a municipal bond fund and an income fund should use after-tax return for both
The best answer is D.
Income funds cannot be compared to growth funds on the basis of income yield because the investment objective of growth funds is to achieve capital appreciation, not income. Thus, Choice A is incorrect.
Any comparison between funds should be over the same period, thus Choice B is incorrect.
A fair comparison will take into account the effect of the sales charges, because one fund may have higher sales charges and thereby reduce the effective investment return. Thus, Choice C is incorrect.
Municipal bond funds are a type of income fund, so they can fairly be compared to another income fund. However, to have a valid comparison, the yield on the income fund must be brought to an “after-tax” basis, since municipal bond yields are free of federal income tax (and state income tax for the purchaser of a bond that lives in the state of issuance). Thus, Choice D is correct.
Which of the following statements concerning comparison of mutual funds are TRUE?
I Comparison of funds over the same period of time is appropriate when the funds have different investment objectives
II Quality of management can be compared by looking at performance over the same period of time
III A fund can achieve high performance for a few years by taking greater risk and then have a period of poor performance
IV Funds with the same investment objectives will have the same risks
A. I and II only
B. II and III only
C. II and IV only
D. III and IV only
The best answer is B.
Quality of management can be compared by looking at performance over the same period of time. Funds with the same investment objectives will not necessarily have the same risks. A fund can achieve high performance for a few years by taking greater risk and then have a period of poor performance. Comparison of funds over the same period of time is appropriate when the funds have the same investment objectives.
When making a presentation to a client that wishes to purchase a mutual fund, the representative compares the 5-year return of the fund to the 10-year return of the Standard and Poor’s 500 Index to illustrate the fund’s performance. This action is:
A. permitted
B. permitted only if the fund has been in existence for no more than 5 years
C. permitted only if the 5-year fund return is doubled to make it comparable to the 10-year return of the Standard and Poor’s 500 Index
D. prohibited
The best answer is D.
This is the case of comparing “apples to apples” and not “apples to oranges.” If a 5-year mutual fund Total Return is being compared to the return of the Standard and Poor’s 500 Index, it must be for the EXACT same time period to be a valid comparison. In such a comparison, the Standard and Poor’s Index Return is the benchmark return against which the fund’s return can be compared.
Which statements are TRUE regarding hedge funds?
I They not only invest in securities, but also in pools of other assets such as commodities and currencies
II They engage in aggressive trading tactics and are highly leveraged
III Adviser compensation is typically based on a percentage of capital appreciation
IV The adviser typically makes a significant personal investment in the hedge fund
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is D.
Hedge funds are set up as private placements, open only to accredited investors. They are illiquid, since money can only be withdrawn once per year (and usually only with general partner approval). They use sophisticated aggressive investment strategies that are high-risk (but these can also be high-reward), including short selling, using large amounts of leverage, and speculating in futures, commodities, and foreign currency markets. Because of this, they are only suitable for sophisticated, wealthy investors that are able to bear risk. Hedge fund managers often invest a large chunk of their personal wealth in the fund, so the investor knows that the manager has a true personal interest in achieving good investment results. Unlike regulated mutual funds, which can only compensate the adviser based on a percentage of assets under management, hedge fund managers typically take both a percentage of assets under management (say 2%) plus a percentage of capital gains in the fund (say 20%). Needless to say, this can result in very rich compensation for successful hedge fund managers.
The manager of an unregistered hedge fund charges a fee of “2 and 20.” This means that investors are charged a(n):
A. annual management fee against net assets of 2% plus a performance fee based on exceeding a benchmark index by 20%
B. annual management fee against net assets of 2% plus a performance fee based on 20% of profits
C. annual management fee against net assets of 20% plus a performance fee based on exceeding a benchmark index by 2%
D. annual management fee against net assets of 20% plus a performance fee based on 2% of profits
The best answer is B.
The typical hedge fund fee is “2 and 20” - a 2% annual management fee as a percent of assets under management, plus 20% of profits. Hedge fund managers are not subject to the Investment Company Act of 1940 that limits manager’s compensation to a percentage of assets under management - no performance fees are allowed. They are structured as private placement limited partnerships that are only available to wealthy accredited investors. They are exempt from securities regulation since the general public cannot invest, except for the anti-fraud rules.
Hedge funds started in the 1990s and the managers produced superior returns and were able to charge high fees. Nowadays, most hedge funds are not doing much better than the overall market, and managers are moving towards a performance fee based on return achieved over a benchmark index, as opposed to a fee based on absolute profits (which might be achieved not because of superior investment choices, but because the market simply went up).
When comparing a mutual fund to a hedge fund, which statement is FALSE?
A. Hedge funds are less regulated
B. Hedge funds are more risky
C. Hedge funds are only available to qualified purchasers
D. Hedge funds are liquid
The best answer is D.
Hedge funds are “lightly regulated” partnership investments only open to accredited (wealthy, sophisticated) investors. The fund manager uses aggressive investment strategies that are risky in order to generate higher returns. Hedge funds’ investments are completely illiquid. Usually, the limited partner investor can only “cash out” at year end. For the rest of the year, the investor is locked into the investment.
A customer who invests in a “fund of hedge funds” should be made aware that:
I there are 2 layers of fees associated with the investment - those of the fund manager; and those charged by the underlying hedge fund managers
II the computation of NAV is difficult because investments may be made in highly illiquid securities that are infrequently traded
III the level of risk associated with the investment is typically higher than that of a mutual fund
IV fund distributions will generally consist of more highly taxed ordinary income and short term capital gains
StatusA A. I and II only
StatusB B. III and IV only
Incorrect Answer C. I, II, III
Correct Answer D. I, II, III, IV
The best answer is D.
A “fund of hedge funds” is a closed end fund registered under the Investment Company Act of 1940 (and therefore sold with a prospectus) that makes investments in selected hedge funds. These “funds of funds” allow smaller investors to participate in alternate investments like hedge funds, though they generally have a minimum $25,000 investment amount, cutting out the truly small investor. In addition, these closed end funds are not listed on an exchange - they do not trade. Rather, they are issued either monthly or quarterly, and they are redeemed through tender offer by the sponsor.
Since the underlying investments are hedge funds, these “funds of funds” are characterized by aggressive trading, high risk, and potentially high reward. Many of the investments made by hedge fund managers are “exotic” and “illiquid,” making the daily mutual fund NAV determination difficult.
The underlying hedge fund manager is compensated with management fees, in addition to the mutual fund manager that selects the hedge fund investments earning management fees, so there is a double layer of fees to this investment.
Because the underlying hedge funds are aggressively traded, resulting gains (and losses) tend to be short-term, making these tax-inefficient investment vehicles.
