Unit 3 - Pooled Investments (Testing) Flashcards
When reviewing the prospectus of a mutual fund, you would be most likely to find a discussion of breakpoints dealing with which share class?
A) Class A
B) Class B
C) Class C
D) Class R
A
Explanation: It is only Class A shares with their front-end load where a schedule of breakpoints is found in the prospectus. Class B and C shares have deferred sales charges, and Class R shares generally have no front-end or back-end loading.
If an investor wants to invest in the electronics industry but does not want to limit his investments to only one or two companies, which type of fund would be most suitable?
A) Bond
B) Money market
C) Specialized
D) Hedge
C
A specialized or sector fund invests 25% or more of its assets in a particular region or industry.
Which of the following clients would be the best candidate(s) for a hedge fund?
A) Howard, age 78, widowed, conservative risk taker, $250,000 net
worth, lives on a fixed income
B) Ted and Alice, late 50s, no dependents, semiretired, $5 million net
worth, moderate risk takers, diversified holdings
C) Marcy, age 23, recent college graduate, student debt, low net
worth, entry-level position at a local law firm
D) Bob and Carol, mid 30s, two young kids, homeowners, $50,000
net worth, long-term investment perspective
B
Explanation: The best choice for a hedge fund is Ted and Alice. They have no dependents, have high net worth, have diversified holdings, and exhibit a moderate risk tolerance. A hedge fund is generally an unregistered, privately offered, managed pool of capital for wealthy, financially sophisticated investors. The other clients would not be considered candidates for a hedge fund based on net worth and investment objectives.
“With regard to taxation of distributions from a REIT, which of these are true?
I. In the majority of cases, dividends are taxed as ordinary income.
II. In the majority of cases, dividends are considered qualified for the
lower tax rate.
III. Capital gains distributions are treated as long-term capital gains.
IV. Capital gains distributions are taxed as ordinary income.
A) II and IV
B) I and IV
C) II and III
D) I and III
D
Explanation: Although there are some rare exceptions, you should consider any dividend paid to an investor in a REIT subject to taxation at ordinary income rates. Just as with mutual funds, capital gains distributions are treated as long-term capital gain.
Who safeguards the securities held in a mutual fund’s portfolio?
A) The manager
B) The custodian
C) The trustee
D) The corporation
B
Explanation: The Investment Company Act of 1940 requires that investment companies employ the services of a commercial bank as custodian to hold and safeguard the physical assets (cash and investment portfolio) of the fund.
Investors with a short time horizon most likely will invest in which class of mutual fund shares?
A) Class C shares
B) Class A shares
C) Class A shares, then convert to Class B shares
D) Class B shares
A
Explanation: Class C shares may be less expensive than Class A or B shares for investors with a short time horizon. The front-end load on Class A shares and the back-end load on Class B shares make them unattractive for short-term investors. Class A shares do not convert to Class B shares; it goes the other way.
If general interest rates increase, the interest income of an open-end bond fund whose sales exceed redemptions will likely
A) not be determined from the information given.
B) remain unchanged.
C) increase.
D) decrease.
C
Explanation: The primary portfolio holding of a bond mutual fund is bonds. When sales exceed redemptions, the fund has a net cash inflow (just like when your income exceeds your expenses). When that continuous flow of “new” money in invested in these higher yielding bonds, the fund’s interest income increases.
Open- and closed-end investment companies have all of the following in common except
A) they trade their shares in the secondary market.
B) they compute their net asset values.
C) they actively manage their portfolios.
D) they have stated investment objectives.
A
Explanation: Open-end companies do not trade shares in the secondary market. However, both open-end and closed-end companies compute their net asset values, actively manage their portfolios, and have stated investment objectives.
A manager of a venture capital fund would be most interested in investing in
A) a young, promising company.
B) a well-established company going through management changes.
C) a company listed on a major stock exchange.
D) a company interested in going private.
A
Explanation: Venture capitalists prefer to get involved in the earlier stages of a company’s development. This would certainly not be a company listed, nor would it be likely that the company is already publicly traded.
“Under the Investment Company Act of 1940, SEC Rule 12b-1 allows a fund to charge distribution and sales expenses to net assets as a percentage of the total assets. Normally, the cost of distribution of the shares is paid by the underwriter out of the sales load paid by the individual purchaser. For a fund to impose 12b-1 charges, which of the following conditions apply (applies)?
I. he board of directors has sole approval authority.
II. he majority of the outstanding shares has sole approval authority.
III. Both the board and the majority of outstanding II. shares must approve it.
IV. A distribution plan must be written.
A) III and IV
B) I only
C) II and III
D) I and III
A
Explanation: For the fund to impose 12b-1 charges, the distribution plan must be in writing and approved by a majority of the outstanding shares, as well as a majority of the board of directors, including a majority of directors classified as outside directors.
A client of yours has been investigating a particular mutual fund. She mentions that she saw a blurb on the internet that the fund has had net redemptions over the past six months and asks you to explain how that might affect the fund’s performance. You should explain which of these?
I. This is a good thing because now, with less money to invest, the
fund’s adviser is able to be more selective.
II. Performance will probably suffer because the fund’s adviser will
have to sell positions prematurely in order to meet redemption
requests.
III. This would be a good time to buy because the supply of shares
exceeds the demand.
IV. Many of the fund’s expenses are relatively fixed, so with less
assets in the fund, the expense ratio will probably increase.
A) II and IV
B) I and III
C) I and IV
D) II and III
A
Explanation: When a fund has net redemptions, it means that less money is coming in than is going out. In order to meet those redemptions, the fund’s manager will either have to sell securities that they planned to hold onto or maintain more assets in cash (which generally will return less than other investments). Because the expense ratio is the annual expenses divided by the average annual assets, with less assets to cover the fixed expenses, the ratio will probably increase.
Which of the following is not a characteristic of a real estate investment trust (REIT)?
A) Relatively low marketability
B) Potential dividends from investment income or capital gains
distributions
C) Shares are traded on exchanges much like the stocks of other
companies
D) Pooling of capital to purchase properties or mortgage loans
A
Explanation: Real Estate Investment Trust (REIT) is a company that pools its capital to purchase properties and/or mortgage loans. Investors buy REIT shares and, in turn, receive dividends from investment income or capital gains distributions. REIT shares are traded on exchanges much like the stocks of other companies. This provides relatively high marketability, especially compared with most other types of real estate investments.
All of the following may receive breakpoint discounts except
A) an investor in an individual retirement account.
B) a husband and wife in a joint account.
C) a pension plan trustee.
D) an investment club.
D
Breakpoints are not available to investment clubs.
An investor invests $25,000 into the KAPCO Balanced fund. It would be unlikely for this investor to be required to pay a CDSC when redeeming
A) Class B shares.
B) Class C shares.
C) any shares, regardless of class.
D) Class A shares.
D
Explanation: Class B shares are known for their back-end load. Class C shares usually only have one for a year, but if the investor redeems within that period, there will be a CDSC. Class A shares do not carry a back-end load, except under conditions that are beyond the scope of this exam.
Starflier Mutual Fund, regulated under the Investment Company Act of 1940, wishes to change its investment policy. It may do so with approval of
A) the fund’s investment adviser.
B) a majority of the board of directors.
C) a majority of the outstanding shares.
D) the Securities and Exchange Commission (SEC).
C
Changes in investment policy require a vote of the majority of outstanding shares for approval.
Which of the following statements is not true?
A) Mutual fund shares may not be purchased on margin because
their shares are always public offerings of new shares.
B) Mutual funds may be used as collateral in a margin account if
they have been owned for more than 30 days.
C) Open-end investment companies must have a minimum of $1
million in assets to have a public offering.
D) The sale of open-end investment company shares is a continuous
public offering and must be accompanied by a prospectus.
C
Minimum assets of $100,000 are required.
An individual wishing to invest $15,000 into a mutual fund with the intent of having it remain invested for at least 15 years should probably purchase
A) Class I shares with no load, no 12b-1 fee, and no CDSC.
B) Class C shares with a 12b-1 fee of 0.75% and a CDSC of 1% during
the first year.
C) Class B shares with a 12b-1 fee of 0.75% and a six-year declining
CDSC after which they convert to Class A shares.
D) Class A shares with a 5.5% front-end load and a 12b-1 fee of
0.25%.”
C
Explanation: There are several keys to answering this question. First is recognizing this is an individual investor. Although Class I shares generally offer the best deal, that share class is sold only to institutional investors. Next, we see that the size of the investment is $15,000. That is too small to reach any significant breakpoint.
Finally, the client intends to hold the investment for at least 15 years, so the CDSC attached to the Class B shares becomes irrelevant. Because the Class B shares are sold without a front-end load, all of the investor’s money goes to work.
True, the 12b-1 charge is 0.50% higher than with the Class A shares, but that only lasts for the six-year period until the B shares convert to A shares. That is a 3% difference over the six years, barely over half as much as the 5.5% front-end load.
The Class C shares have no front-end load and the CDSC is unimportant here because it disappears after 1 year, but the 12b-1 fee never ends, over a 15-year or longer period, that can remove the advantage the lack of a front-end load has to offer.
Why would you suggest a client invest in international mutual funds or ETFs?
I. Diversification
II. Tax benefits
III. Avoids having to pick individual stocks
IV. Greater regulatory controls
A) II and III
B) I and III
C) I, II, III, and IV
D) I and IV”
B
Explanation: An international mutual fund (or ETF) invests in the securities of companies that are not domiciled in the United States. Therefore, we have the benefit of added diversification.
These pooled investment vehicles offer investors the specific benefit (whether foreign or domestic) of not having to worry about individual stock selection, the professional managers do that.
There are no specific tax benefits to investing through the fund rather than directly, and in most cases, the regulatory controls in other countries do not offer the same degree of investor protection as those of the United States.
According to the Investment Company Act of 1940, an open-end investment company must compute its NAV
A) monthly.
B) weekly.
C) no less frequently than once per day.
D) annually.
C
Explanation: Mutual funds must calculate the value of fund shares at least once per business day; funds may calculate the value more often and will disclose this fact in the prospectus.
A prospect has primary investment objectives of current income and safety of principal. During the initial public offering of a closed-end government bond fund, an agent explains to the prospect that the fund invests in U.S. government?backed bonds, which are very safe as to principal, and plans to make monthly distributions. Little could therefore go wrong. Taken as a whole, this representation is
A) accurate because the fund invests in government bonds.
B) accurate because the fund offers current income.
C) misleading because closed-end fund shares are subject to market
pricing.
D) misleading because government bonds experience considerable
credit risk.
C
Explanation: Though parts of the agent’s presentation are factually accurate, overall, the statements are misleading because the value of the fund is subject to unpredictable change. Closed-end funds can, and often do, trade below their net asset value, thus subjecting the customer’s principal to risk.
The most common form of investment vehicle for venture capital is
A) the limited liability company.
B) the limited partnership.
C) the venture capital fund of funds.
D) the corporate venture capital funds.”
D
The limited partnership structure is by far the most common for venture capital.
A review of the prospectus of an open-end investment company reveals that its portfolio consists entirely of negotiable CDs, Treasury bills, and commercial paper. This is probably
A) an exchange-traded fund (ETF).
B) a balance fund.
C) a money market fund.
D) an index fund.
C
Money market funds hold money market instruments like negotiable CDs, Treasury bills, and commercial paper.
One of your clients is interested in investing in a large-cap growth fund and has a list of several that she has been investigating. When helping her compare, each of the following factors would be relevant except
A) dates that dividends are paid.
B) expense ratio.
C) tenure of the fund manager.
D) past performance compared to the S&P 500.”
A
Explanation: Tenure of the fund manager, expense ratio, and performance relative to a benchmark are all relevant factors to use when comparing mutual funds. However, the date that dividends are paid is not a significant factor.
The fee charged by some mutual fund companies if shares are redeemed within a specified time after being purchased is known as
A) a breakpoint fee.
B) a forward pricing fee.
C) a contingent-deferred sales charge.
D) a 12b-1 fee.
C
Explanation: Some mutual funds impose contingent-deferred sales charges (CDSC) on investors who redeem their shares within a specified period after purchasing them.
These fees are designed to encourage investors to leave their money in the fund for longer periods. Typically, the amount of the contingent-deferred sales charge decreases the longer the investor owns the shares.
A 45-year-old client has just received an inheritance and would like to invest $100,000 into a growth mutual fund offered by your firm. The client intends to use the money to supplement retirement. You should probably recommend the purchase of
A) Class C shares
B) a fixed annuity
C) Class B shares
D) Class A shares
D
Explanation: At a purchase level of $100,000, a breakpoint will be reached which should bring the front-end load to a low level. Combine that with the generally lower operating expenses and the expected long-term holding period and the regulators would like to see the investment in Class A shares. There is nothing wrong with a fixed annuity except the client wants a mutual fund.
By their very nature, pooled investment vehicles offer investors
A) tax deferral.
B) diversification.
C) current income.
D) guaranteed returns.”
B
Most pooled investment vehicles invest in a broad range of investments, giving their investors diversification.
The Investment Company Act of 1940 requires that a mutual fund do which of the following?
I. Provide a monthly balance sheet to investors
II. Have $100,000 minimum capitalization prior to making a public
offering
III. Provide semiannual reports to shareholders
IV. Not acquire more than 5% of the outstanding shares of another
registered investment company
A) I and III
B) I and IV
C) II and IV
D) II and III
D
Explanation: The Investment Company Act of 1940 requires that an open-end investment company have a minimum of $100,000 in net assets prior to commencing a public offering. Reports must be sent to shareholders on a semiannual basis. No fund is permitted to own more than 3% of the outstanding shares of another registered investment company.
ABC Investment Company shares are trading at $13.80 on a per-share basis. The net asset value (NAV) per share is $12.00. Which of the following conclusions correctly defines the relationship between trading price and NAV?
A) The fund’s shares are trading at a premium of 15% to the NAV.
B) The value of $13.80 is calculated as total assets minus total
liabilities divided by total outstanding shares.
C) The fund’s shares are trading at a discount of 15% to underlying
NAV.
D) NAV per share is calculated as per-market demand and supply for
the fund’s shares.
A
Explanation: This is a closed-end investment company whose shares are trading at a premium. The premium is 15% relative to the underlying NAV ($1.80 ÷ $12.00). The market price, not the NAV of the fund’s shares, is determined by supply and demand in the market.
As is the case with many math questions, there is more than one way to find the answer. Some may find it easier to divide the trading price of $13.80 by the NAV of $12. The result is 1.15 meaning the price is 15% higher than the NAV. Use whichever method is best for you. How do we know this is not a mutual fund? There are two ways. Mutual funds do not trade; there is no secondary market for them. Secondly, the sales charge is 13.8% ($1.80 ÷ $13.80), which is far above the maximum 8.5% allowed.
Which of the following statements regarding letters of intent used in connection with mutual fund purchases are true?
I. The letter can cover a period totaling 16 months.
II. The letter may be backdated 90 days.
III. Some shares purchased are held in escrow until the letter is
completed.
IV. During the period covered by the letter, the customer may not
redeem his shares.
A) III and IV
B) II and III
C) I and IV
D) I and II
B
Explanation: Letters of intent permit investors to qualify for a reduced sales charge on the purchase of mutual fund shares over time. They are valid for 13 months and may be backdated by up to 90 days to include previous purchases.
The investor is not legally obligated to comply with the terms of the letter, so some shares purchased at the reduced sales charge are held in escrow. These shares are liquidated to repay the reduction in sales charge if the contract is not completed.
Many investors consider purchasing an equity exchange-traded fund (ETF) to increase portfolio diversification. All of the following are reasons for investors to purchase this investment except
A) shares may be purchased and sold throughout the day.
B) they have lower taxable distributions than most mutual funds.
C) ETFs offer tax benefits similar to a limited partnership.
D) they have lower annual expenses than those of mutual funds.
C
Explanation: Equity ETFs are often organized as regulated open-end investment companies and rarely as limited partnerships (never on the exam). Therefore, they must distribute at least 90% of their net investment income and capital gains.
However, the method by which those capital gains are realized by the ETF is different from that of a mutual fund and, in almost all cases, results in lower taxable capital gains distributions. Unlike limited partnerships, there is no flow-through of losses. Expenses are generally lower as well, and ETFs trade during the day just like any stock.
