Unit 2: Investment Company Securities & Variable Contracts Flashcards
Variable Annuities
popular retirement instrument that may invest in mutual funds or may invest directly in individual securities for the purpose of funding a customer’s retirement
most suitable for someone who can fund the contract with cash
not suitable for anyone who might need the lump sum of cash back
Investment Company Act of 1940
three types of investment companies:
- face-amount certificate companies (FACs)
- unit investment trusts (UITs)
- management investment companies
requires that a mutual fund must have $3 of assets for each $1 it borrows
Face-Amount Certificate Companies (FACs)
contract between an investor and an issuer in which the issuer guarantees payment of a stated (face amount) sum to the investor at some set date in the future
- classified as investment companies
- pay a fixed rate of return
- do not trade in the secondary market but are redeemed by the issuer
very few operate today
Unit Investment Trusts (UITs)
- investment companies
- UIT shares are not traded in the secondary market, they must be redeemed by the trust
- UITs are not actively managed, there is no board of directors or investment advisor
fixed UIT: purchases a portfolio of bonds and terminates when the bonds in the portfolio mature
nonfixed UIT: purchases shares of an underlying mutual fund
similar to a mutual fund
Management Investment Companies
actively manages a securities portfolio to achieve a stated investment objective
either closed-end or open-end
both sell shares to the public in an initial public offering
can be diversified or nondiversified
Closed-end Investment Companies
- fixed, single offering of shares
- may issue common and preferred stock and debt securities
- issues full shares only
- initial primary offering limited to authorized number of shares to be sold, secondary trading in OTC or on an exchange, does not redeem shares
- price determined by supply & demand
- shareholder rights: dividends, voting, and preemptive rights
- are sold with prospectus during IPO only
- FINRA sets ex-date
Open-end Investment Companies
- unlimited, continuous offering of shares
- issues common stock only
- issues full or fractional shares
- sold and redeemed by the fund only, continuous primary offering, must redeem shares
- Shareholder rights: dividends, voting
- board of directors sets ex-date
may borrow from banks provided their asset-to-debt ration is not less than 3:1 or 300%
similar to mutual funds
Diversified investment company
one that meets requirements of the 75-5-10 test
75% of fund’s total assets must be invested in securities issued by companies other than the investment company itself or its affiliates
no more than 5% of fund’s total assets are invested in the securities of any one issuer (part of 75%)
no more than 10% of the outstanding voting securities of any one issuer is owned (part of 75%)
NonDiversified Investment Company
does not meet the 75-5-10 test
Hedge Funds
type of equity security with similarities to a mutual fund
hedge fund does not have to register with the SEC
have high min. initial investment requirements and are only available to accredited investors
free to adopt far riskier investment policies than ordinary mutual funds
Real Estate Investment Trusts (REITs)
- an owner of REITs holds an undivided interest in a pool of real estate investments
- trade on exchanges and OTC
- not investment companies (open or close-end)
- offer dividends and gains to investors but do not pass through losses like limited partnerships and are not considered to be direct participation programs (DPPs)
SEC registration
companies may register for SEC if they are
1. in the business of investing in, reinvesting in, owning, holding or trading securities
OR
2. 40% or more of the company’s assets are invested in securities
need at least $100,000 in net assets and clearly defined investment objective
two parts:
1. Part 1, N1-A Prospectus
2. Part 2, statement of additional information (SAI)
disclaimer
Investment Company Prospectus
mutual funds must always be sold with a prospectus
closed-end funds must be sold with prospectus in their IPO only
financial info in a prospectus may be no more than 16 months old
Margin
the use of money borrowed from a bank through a brokerage firm to purchase securities
Mutual Fund trading activities prohibited by the SEC
margin account trading
short selling
joint account trading
naked (uncovered) options trading strategies
Board of Directors duties
defines the type of funds to offer
defines the fund’s objective
approves/hires the transfer agent, custodian and investment advisor
at least 40% of directors must be independent or non interested persons
Underwriter
distributes fund shares
paid by sales charge
Transfer Agent
customer service
redeems shares
paid from fund income
Custodian
safekeeper of funds and securities
paid from fund income
generally a commercial bank
investment advisor
trades the portfolio
adheres to portfolio objectives
paid from fund income
fee is largest fund expense
Statutory Prospectus (full)
- must be distributed to an investor before or during the solicitation
- contains fund’s objective, investment policies, sales charges, management expenses, and services offered
- discloses 1, 5, & 10 year performance histories or performance over the life of the fund whichever is shorter
Summary Prospectus
summary of key information in the fund’s statutory prospectus
after receiving this, investors will either purchase fund shares using the application found therein or request a statutory prospectus
if investor purchases fund shares after summary prospectus, they must receive a copy of the statutory prospectus no later than the confirmation of the sale
Statement of Additional Information (SAI)
required by Mutual funds and closed-end funds to have available to investors upon request without charge
additional info from prospectus
- blaance sheet
- statement of operations
- income statement
- portfolio list at the time the SAI was compiled
Financial Report
Investment Company Act of 1940 requires that shareholders receive financial reports at least semiannually
one of these must be an audited annual report
Mutual Funds Characteristics
- offer guaranteed marketability
- redeemable securities, do not trade in secondary market
- professional investment adviser manages the portfolio for investors
- provide diversification by investing in diff companies
- allow minimum investment $500 or less to open an account and allow additional investment for as little as $25
- investor has voting rights of one vote per share
- contain manage portfolios
- regulated by investment company act of 1940
Net Asset Value (NAV) formula
determines price of mutual fund shares because they don’t trade in the secondary market so value is not determined by supply and demand
Total Assets - Liabilities = Net Assets
Net Assets/Shares Outstanding = NAV
calculated at least once per business day usually cat 4pm ET every business day
Public Offering Price (POP)
purchase price of a fund share
for front-end loaded shares it is NAV + sales charge
FINRA sales charges restrictions
members are prohibited from assessing sales charges in excess of 8.5% of the POP on customers’ mutual fund perchases
closed-end funds
may trade at a premium (above) or a discount (below) relative to their NAV
in IPO do not have sales charge imbedded in share price
in secondary market, investor pays a brokerage commission or pays a markup or markdown
spread between NAV and POP must be greater than 8.5%
open-end funds
all sales commissions and expenses are embedded in the POP or other fees
front-end loads
back-end loads
level loads
spread between NAV and POP must be 8.5% or less
may never be greater than POP
Front-end loads
called Class A shares
the charges included in a fund’s public offering price
most common way of paying for the distribution services a fund’s underwriter and broker/dealers provide
Back-end loads
Class B shares
charged if and when an investor redeems mutual fund shares
often called a CDSC
Level loads
Class C shares
appropriate for investors that have short time horizons as they become quite expensive to won if investing for more than 4 or 5 years
12b-1 fees or asset-based distribution fees
used to cover the costs of marketing and distributing the fund to investors
used to compensate registered representatives for servicing an account but shouldn’t be confused with sales charges
- approval requires 3 votes: majority of the outstanding voting securities, full board, and the noninterested members of the board
- renewal (done annually) requires two votes
- termination requires either a majority of the outstanding voting securities or the noninterested members of the board
- charges covered by 12b-1 fees include advertising, sales literature, and prospectuses delivered to potential customers, not fund management expenses
- fund may charge no more than .25% of average net assets for 12b-1 fees
- max. charge is .75% for distribution and promotion
- charged and reviewed quarterly
- FINRA allows an additional .25% charge for shareholder services but that is treated separate from 12b-1 charge
Sales Charge percentage formula
when NAV and POP are known
POP - NAV = sales charge dollar amount
sales charge dollar amount/POP = sales charge percentage
Name Rule
instituted to prevent abuse
requires a registered investment company with a name suggesting that the company focuses on a particular type of investment such as stocks, bonds, federal or municipal debt invest at least 80% of its assets in the type of security indicated by its name
a small-cap, mid-cap, or large-cap fund seeking max flexibility with respect to its investments would be free to select a name that does not connote a particular investment emphasis
Large-cap funds
growth with low risk
companies with market capitalization of more than $10 billion
Small-cap funds
capital gains/higher risk
companies with market capitalization of less than $2 billion
Mid-Cap funds
companies with market capitalization of between $2 and $10 billion
Income funds
stresses current income over growth
Specialized Sector Funds
specialize in particular economic sectors or geographic areas
wishes to invest in medical technology and is not risk averse
must have a min. of 25% of their assets invested in their specialties
Special situation funds
buy securities of companies that may benefit from a change within the companies or in the economy
seek investments in undervalued companies
Blend/core funds
stock funds with a portfolio comprised of a number of different classes of stock (growth stocks and value stocks)
Index funds
invest in securities to mirror a market index, such as the S&P 500
Foreign stock funds
invest mostly in the securities of companies that have their principal business activities outside the US in order to diversify an investor’s portfolio
long term capital appreciation is their primary objective, although some funds also seek current income
Principal Protected Funds
- closed to new contributions during their protected periods
- protect initial principal for those mutual fund shares that are held to maturity, but interim gains generated on such principal are not protected
- typically front-end loaded
Balanced funds
known as hybrid funds
invest in stocks for appreciation and bonds for income
diversify securities and is conservative
capital gains/income/lower risk
Asset Allocation Funds
purchase variety of assets to achieve capital gains, income, diversification, low risk
split investments between stocks for growth, bonds for income, and money market instruments or cast for stability
fund advisers switch the percentage of holdings in each asset category according to the performance of that group
Bond Funds
income is their main investment objective
- corporate bond funds
- tax-free bond funds
- US government and agency security funds
Corporate Bond Funds
- have higher credit risk than various government issues but can still be classified as investment grade or non investment grade (riskier)
Municipal Bond Fund
dividends are federally ta exempt and capital gains are subject to taxation
US Government and Agency Security Funds
purchase securities issued by the US Treasury or an agency of the US government such as Ginnie Mae
investors seek current income and maximum safety
Money Market Funds
open-end funds that serve as temporary holding tanks for investors who are most concerned with liquidity and safety
Blue-chip funds
invest in established more recognized companies with large market capitalization to achieve growth with less risk
desires capital growth with minimal risk
Conservative growth fund
capital gains/low risk
Aggressive growth fund
wishes to maximize capital gains quickly with high risk tolerance
Fund of hedge funds
possibly enhanced growth/high risk
Factors when comparing mutual funds
- performance
- costs
- taxation
- portfolio turnover
- services offered
Mutual Funds Performance
law requires each fund disclose the average annual total returns for 1, 5, and 10 year periods or as long as fund has operated
performance must reflect full sales loads with no discounts
Mutual Funds Costs
sales loads, management fees and operating expenses reduce investor returns because they reduce the amt of money available for investment
expense ratio
for all mutual funds
calculated by dividing a fund’s expenses by its average net assets
usually between 1% and 1.5% of a fund’s average net assetts
*factors effecting expense ratio:
1. BOD stipend
2. investment adviser fee
3. custodian fee
4. transfer agent fee
5. 12b-1 fee
6. legal and accounting expenses
sales load not included
Portfolio turnover ration
reflect costs of buying and selling securities and a fund’s holding period
aggressive growth funds often have a turnover rate of 100% or more meaning it holds its securities on average for less than one year
services mutual funds offer
- retirement account custodianship
- investment plans
- check-writing privileges
- telephone transfers
- conversation privileges
- combo investment privileges
- withdrawal plans
Voluntary accumulation plan
mutual fund investment plan
allows a customer to deposit regular periodic investments on a voluntary basis
flexible contribution and frequency
Dollar Cost Averaging
- investing a fixed amount of money every period, regardless of market price fluctuation
purchases more shares when prices are low and fewer when prices are high
does not guarantee profits in a declining market just results in a lower cost per share than the average price per share
Contractual Plans
no longer sold
nonbinding agreement to make periodic payments (monthly) to the plan company for a specific period (10 or 20 yrs) to be invested in a particular mutual fund
**
Front-end load:
- maximum sales charge that may be withdrawn in any one year = 50%
Spread load:
- max average sales charge that may be withdrawn over any 4-year period = 16%
- max sales charge that may be withdrawn in any one year = 20%
9% max sales charge percentage over the life of any contractual plan (both front-end and spread load)
Withdrawal Plans
- fixed-dollar plan
- fixed-percentage or fixed-share plan
- fixed-time plan
- never guaranteed rate of return
- charts and tables must be cleared by SEC before use
*RISK: investor may outlive his income
fixed-dollar withdrawal plan
customer pay request the periodic withdrawal of a fixed-dollar amount
fund liquidates enough shares each period to send that sum
fixed-percentage or fixed-share withdrawal plan
either a fixed number os hares or a fixed percentage of the account is liquidated each period
fixed-time withdrawal plan
customers liquidate their holdings over a fixed period of time such as 10 years
amount of each check is determined by the performance of the fund and therefore unknown
Types of Mutual Funds
B- Balanced BD - bond C - common CN - Canadian CV - convertible bond, preferred stock FL - flexible H - hedge L - leverage P - preferred SP - specialized TF - tax-free
Annuity
an insurance contract designed to provide retirement income
payments guaranteed for the life of the annuitant, until the annuitant reaches a certain age, or for a specific number of years
amount to be paid not guaranteed
*mortality guarantee
Fixed Annuity
investors pay premiums to the insurance company that are invested in the company’s general account
guaranteed rate of return
inflation risk
Index Annutity
market participation with a guarantee against loss based on performance of S&P 500
participation rate (max growth) guaranteed minimum interest rate
Variable Annuity characteristics
investor assumes the investment risk
must be sold with prospectus by individuals with insurance license and securities license
invested in separate account (have diversified portfolios of common stock), not guaranteed
contain manage portfolios
regulated by investment company act of 1940
have voting rights on investment policy and investment advisor one vote per share
guarantees fixed mortality expense and fixed administrative expense and minimum ROR
Immediate Annuity
purchased with a lump sum and the payout of benefits usually commences within 60 days
Bonus Annuities
enhancement of buyer’s premium with insurance company contributing an additional 3-5% to the premium payment
higher fees and expenses, longer surrender periods than typical 7-10 years
accumulation stage
growth phase
number and value of accumulation units is used to calculate the total number of annuity units
annuity phase
payout phase
Life Annuity/Straight Life
company will pay annuitant for life, but when they die the insurer keeps the leftover
largest monthly income
Annuity with Period Certain
period of 10-20 years of guaranteed payments even if annuitant dies
if annuitant lives to age 150 they would keep receiving benefits but if they die in 5 years, beneficiary would receive income for 5 more years
Joint Life with Last Survivor Annuity
guarantees payments over two lives
smaller check than period certain
Unit Refund Option
minimum number of payments are made upon retirement
if value remains after death it is payable in lump sum to beneficiary
guarantees full refund
Largest to Smallest Monthly Income Annuity Options
- Life only
- Life with 10 year period certain
- Joint and last survivor
- Unit refund
Deductions form the gross premium in Variable Life
(acronym PASS)
- premiums
- administrative fee
- sales load
- state premium taxes
Deductions form the seperate account in Variable Life
- mortality risk fee (COI): risk policyowner may live past assumed age
- expense risk fee: risk the costs of administering and issuing policy are greater than assumed
- investment management fee
Frequency of DB, cash value, and unit value calculations
DB = annually CV = monthly UV = daily
Frequency of DB, cash value, and unit value calculations VL
DB = annually CV = monthly UV = daily
Contract Exchange VL
VL for WL contract
must be available for a min. of 2 years
no medical underwriting is required
Free-Look Period VL
45 days from submitting application
or
10 days from receiving policy
whichever is longer
if insured wants refund, get all money paid back
VL voting rights
one vote per $100 CV funded by separate account
VL voting rights
one vote per $100 CV funded by separate account
Life insurance settlement options
- lump sum
- second to die
- annuity
- interest income only
