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Series 7 > unit 8 > Flashcards

unit 8 Flashcards

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Series 7 Top-off Exam flashcards
1
Q

investment company

A
  • corporation or trust through which investors may acquire an interest in large, diversified portfolios of securities by pooling their funds with other investors’ funds and buying shares or units of the fund
  • investment company act of 1940 provides for SEC regulation
  • subject to regulation about how shares are sold to the public
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2
Q

types of investment companies

A
  • face amt cert (FAC)
  • unit investment trust (UIT)
  • management investment companies
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3
Q

face amt cert (FAC) companies

A
  • a contract between an investor and an issuer where the issuer guarantees payment of the stated/fixed sum to the investor at some set date in the fire.
  • investor agrees to pay the issuer a set amt of money in lump sum or installments
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4
Q
  • unit investment trust (UIT)
A
  • unmanaged investment company organized under a trust indenture
  • UITs do NOT: have a BOD, employ investment advisor, or actively manage the portfolio
  • issues only redeemable securities (units or shares of beneficial interest) which rep an undivided interest in a portfolio of specified securities.
  • portfolio remains fixed
  • sold by prospectus
  • trustees must maintain secondary markets in the units to allow investors to redeem their units at NAV
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5
Q

management investment company

A
  • actively manages a securities portfolio to achieve a stated investment objective.
  • closed end or opened end
  • ## mutual funds are opened end investment company
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6
Q

net asset value

A

NAV = (value of fund assets - liabilities)/ # of outstanding shares

  • mutual fund’s NAV is calculated daily by deducting the fund’s liabilities from its total assets
  • NAV per share = fund’s NAV/# of outstanding shares
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7
Q

diversified management company

A

meets requirements of 75-5-10 test:
- at least 75% of the fund’s total assets are invested in cash/securities issued by companies other than the investment company itself or =affiliates
- that 75% must be invested so
- no more than 5% of the fund’s total assets are invested in the securities of any one issuer and
- no more than 10% of the outstanding voting securities of any one issuer is owned

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8
Q

opened end investment companies (mutual funds) initial capitalizations

A
  • does not specify exact # of shares it intends to issue
  • can raise an unlimited amt of capital by continuously insuring new shares
  • requires to deliver a prospectus prior to or concurrent with the sale
  • investors in mutual funds are always buying a NEW issue
  • can only issue common stock
  • can buy preferred stocks and bonds but can’t issue them
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9
Q

closed end investment companies initial capitalizations

A
  • registers a fixed # of shares with the SEC and offers them to the public for a limited time through an underwriting group
  • investors close their position by selling on the secondary markets. Cannot redeem back to the company.
  • can issue common stock, preferred stock and bonds
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10
Q

interval funds

A
  • closed end investment company traded under the investment act of 1940
  • do NOT trade in the secondary market
  • periodically (month to annual) investors can sell portion of shares back to the fund at NAV
  • fund can take more illiquid positions
  • suitable for investors with long time horizon
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11
Q

business development company (BDC)

A
  • created by an act of congress in 1980
  • create a vehicle to aid in the promotion and development of small businesses
  • closed end investment company regulated under the investment company act of 1940
  • at least 70% of assets must be “eligible”
  • must make available significant managerial assistance - is an operating company
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12
Q

eligible portfolio company

A
    • any issuer that doesn’t have any class of securities listed on a national securities exchange, unless they have an aggregate MV of outstanding voting and nonvoting common equity of less than 250mm
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13
Q

pricing of closed end investment company shares

A
  • closed end investment companies are know as publicly traded funds
  • supply and demand determine bid and ask prices
  • shares typically trade at a premium or discount to NAV
  • trade in secondary market or OTC
  • market price is independent of NAV
  • NAV is typically only computed once a week
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14
Q

pricing of open end investment company shares

A
  • anyone can buy shares directly from the company or its underwriters at the public offering price (POP)
  • no secondary trading
  • sells redeemable securities
  • when investors liquidate their shares the company redeems them at NAV
  • mutual fund’s capital decreases when investors redeem
  • shares can be bought as full or fractional units
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15
Q

public offering price (POP)

A

NAV per share + sales charge

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16
Q

forward pricing

A
  • mutual funds must calculate NAV at least once a day, typically close of markets
  • whenever an order to buy/sell shares is received the price is based on the next computed NAV per share
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17
Q

FINRA rule 2341

A
  • prohibits embers who under fund shares from assessing sales charges in excess of 8.5% of the POP on the purchase of open end investment company shares
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18
Q

cost to purchase mutual funds

A
  • all sales commission and expense for an open ended fund are embedded in the POP or other fees
  • sales expenses include commission for the underwriter, BDs, reg reps, advertising and sales materials
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19
Q

class A shares

A
  • front end loads (difference between POP and NAV)
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20
Q

Breakpoints

A
  • available to any person
  • person includes: married couples, parents and minor kids, corporations and certain other entities.
  • breadpoints vary across mutual fund families
  • must disclosure breakpoint schedule in the prospectus
  • discounts can be the result of single large investment, aggregated investments of Letter of intent
  • purchases made by same investor across accounts can be aggregated
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21
Q

breakpoint sales

A

selling investment company shares in a dollar amt just below the point where the sales charge is reduced

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22
Q

letter of intent (LOI)

A
  • investor may be eligible for fee reduction if they add to their investments within 13 months
  • one sided contract binding on the fund only
  • the customer must complete the investment to qualify for the reduced sales charge
  • often can backdate letter, 90th day after an initial purchase
  • may not cover more than 13 months in total
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23
Q

rights of accumulation

A
  • allow an investor to qualify for reduce sales charges
  • allow the investor to use prior share appreciation and reinvestment to qualify for breakpoints and do not impose limits
  • mutual fund general bases the quantity of securities owned in the higher of current NAV or the total purchases made to date
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24
Q

computing the sales charge %

A
  • when NAV and POP are known you can compute the sales charge %

POP - NAV = sales charge dollar amt

(sale charge dollar amt)/POP = sales charge %

  • when dollar amt of NAV and sales charge are know, you can find POP

NAV/(100%-sales charge %)= POP

  • mutual fund prospectus must have formula that shows how fund competes the NAV and how sales charge is added.
  • sales charge is always based on the POP
  • bc of sales charge loaded funds should be recommended for long term investing
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25
Q

class B shares

A
  • back end load/contingent deferred sales charge (back end charge for early redemption of shares)
    • normally declines to 0 over time
    • once charge is eliminated, almost all class B shares convert to Class A shares
  • do not impose sales charge at time of purchase
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26
Q

class C shares (level load)

A
  • typically have a 1 yr 1% contingent deferred sales charge, a 0.75% 12b-1 fee and a 0.25% shareholder service fee
    -appropriate for investors with a short time horizon
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27
Q

12b-1 fee

A
  • asset based distribution fee
  • used to cover marketing and distribution costs
  • compensation reg reps
  • fee is deducted quarterly as a % of the fund’s average total NAV
  • max fee is 0.75% for distribution and promotion
  • FINRA allows an additional 0.25% service fee
  • expressed as an annual amt, but shared and reviewed quarterly
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28
Q

no load fund

A
  • doesn’t charge any type of sales fee, but may charge fees for other things like redemption fees
  • can still pay annual operating expenses and be no load
  • combined total of the fund’s 12b-1 fees and separate shareholders services fees cannot exceed 0.25% of the fund’s average annual net assets
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29
Q

expense ratio

A
  • expresses management fees and operating expenses as a % of the fund’s net assets

expense ratio = annual operating expenses/average dollar value of the fund’s AUM

  • sales charge is not considered an expense when calculating a fund’s expense ratio
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30
Q

cost of entry

A
  • initial investments start at $1000
  • additional investments as little as $25
  • owner of one share has an undivided interest in the entire portfolio of the fund
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31
Q

dollar cost averaging

A
  • invests identical amts an regular intervals to end up with lower average cost per share than average price per share
  • purchase more shares when prices are low and fewer when prices are high
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32
Q

withdrawal plans

A
  • mutual funds are easy to withdraw from
  • can do lump sum withdrawal, fixed dollar withdrawal, fixed % or share withdrawal, fixed time withdrawal
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33
Q

fixed dollar withdrawal

A
  • request periodic withdrawal of a fixed dollar amt
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34
Q

fixed % or share withdrawal

A
  • a fixed % or # of shares is liquidated each period
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35
Q

fixed time withdrawal

A
  • customer liquidate holdings over a fixed period
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36
Q

withdrawal plan disclosures

A
  • withdrawal plans are not guaranteed
  • mutual fund’s require a customer’s acct to be worth a min amt before the withdrawal plan can begin
  • reg rep must:
    • never promise an investor a guaranteed ROR
    • stress that overwithdrawing can occur
    • stress that during a down market the acct could be exhausted with only a small withdrawal
    • never use charts or tables unless the SEC clears their use
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37
Q

voluntary accumulation plans

A
  • allows a costumer to deposit regular periodic investments on a voluntary basis (min amt is in prospectus)
  • help investors form regular investing habit while offering flexibility
  • may require min initial purchase and min additional purchase amt
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38
Q

family of funds or fund complex

A
  • when a single sponsor or distributor offers more than 1 fund
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39
Q

changes within a family of funds

A
  • exchange privileges allow an investor to confer an investment in 1 fund for an equal investment in another fund in the same family without incurring an additional sale charge
  • any gain or loss from the redemption must be reported for tax purposes
  • purchase must no exceed the proceeds generate by the redemption of the other fund
  • redemption may not involve a refund of sales charge
  • sales personnel and deals get no compensation
  • taxable event
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40
Q

mutual fund dividend distributions

A
  • investment company act of 1940 requires a written statement to accompany divided payments by management companies.
  • must clearly indicate what the payment per share is made from
  • mutual fund dividends are typically paid from the fund’s net investment income on a quarterly basis
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41
Q

net investment income (NII)

A

NII = dividends + Interest - expenses of the fund

  • includes gross investment income (dividend and interest income from securities - operating expenses); management fees; custodian fees; legal/accounting fees.
  • advertising and sales expenses are not included
42
Q

conduit theory

A
  • if the mutual fund acts a conduit for the distribution of NII, the fund may qualify as a regulated investment company - meaning it is subject to tax only on the amt of NII the fund retains, the portion of NII distributed is not taxed
  • must distribute at least 90% of NII to shareholders
43
Q

mutual fund capital gains distributions

A
  • when the fund sells securities, gain or loss is realized
  • capital gains distributions are derived from net realized gains
  • fund compares realized gains and losses to determine the net result
  • the fund will only distribute its long term capital gains once a taxable year
  • short term capital gains are distributed as dividends - non qualified dividend and tax at ordinary income rate
  • when the investor sells shares the holding period matters for short term vs long term status
  • factors used to determined tax on capital gains are: length of the time the Fund has held the securities and investors tax bracket
  • capital gains can be distributed as cash or reinvested
  • distributions are taxable
44
Q

reinvestment of distributions

A
  • automatic reinvestment of distributions to purchase additional shares
  • al mutual funds after April1, 2020 mist offer this without sales charge
45
Q

taxation of reinvested distributions

A
  • constructive receipt - income like dividends although not physically received is constructively received in the taxable year during which it is credited to his account or made available
  • form 1099 DIV details tax information related to dividend distributions for the year
  • dividends are reported as qualified (taxed at a lower rate) or non qualified (taxed as ordinary income)
  • any short term gain is distributed as a non qualified dividend
46
Q

stock funds

A
  • uses stocks to meet its objectives
  • typically contain common stock that has growth as a secondary objective
  • equity funds have historically outpaced inflation over 10 yr time horizons
47
Q

growth/value funds

A
  • invest in stocks of companies who businesses are growing
  • growth companies tend to reinvest in R&D instead of dividends
  • focused on generating capital gains
  • considers stock that some feel are overvalued as there might be more upside
  • ## increased risk
48
Q

blue chip or conservative growth funds

A

-invest in established companies to achieve growth with less risk
- companies tend to have large market cap

49
Q

market cap

A

total # of shares of common stock outstanding x current MV per share

50
Q

large cap funds

A
  • portfolio consists of companies with a market cap of more the $10B
  • can more stable and less volatile
51
Q

aggressive growth/ performance funds

A
  • greater risk to max cap appreciation
  • invest in newer companies with small market cap (less than $2B) - small cap funds
  • greater volatility
52
Q

mid-cap funds

A
  • less aggressive and portfolio companies have a market cap of $2-$10B)
53
Q

large cap funds

A
  • greater than $10B
54
Q

value funds

A
  • focus on undervalued company’s stock
  • higher dividend yields than growth stocks
  • more conservative than funds managed for growth or blend/core funds
55
Q

equity income funds

A
  • stresses current value over growth
  • invest in companies with long histories of dividend payments - utilities company stock, blue chip stocks, and preferred stock
56
Q

option income funds

A
  • invest in securities on which call options can be sold (covered calls)
  • earn premium income from writing (selling) the options
  • might also earn cap gains from trading options at a profit
  • greater risk thank other income funds
57
Q

growth and income funds (combination fund)

A
  • combine objectives of growth and current income by diversifying its portfolio between companies with long term growth potential and companies paying high dividends
58
Q

specialized (sector) funds

A
  • min 25% of their assets in their specialties
  • offer high appreciation potential but pose higher risks due to concentration of investments
  • speculative
59
Q

special situation funds

A
  • buy securities of companies that might benefit from a within the company or economy
  • speculative
60
Q

blend/core fund

A
  • stock fund with a portfolio of a # of different classes of stock like blue chip and high risk/high potential growth stocks
  • growth and value management styles are used
  • diversify investments
61
Q

index funds

A
  • invest in securities that mirror an index
  • lower management costs
62
Q

internations funds

A
  • invest only in foreign companies
  • HQ and principle buiness activity outside the US
  • long term capital appreciation
63
Q

global/worldwide funds

A
  • invest in US and foreign companies
  • currency and political risk
  • diversification
64
Q

balanced/hybrid funds

A
  • invest in stocks for appreciation n bonds for income
  • for investors who seek a conservative balance
65
Q

asset allocation funds

A
  • split investments between stocks for growth, bonds for income and money market or cash for stability
  • % changes depending on performance
  • can hold hard assets and real estate
  • target funds are an example
66
Q

target date/life cycle fund

A
  • designed to help manage investment risk
  • gradually reduces risk over time
67
Q

bond funds

A
  • income is the main investment objective
  • some investors looking for enhanced safety only invest in govt issued bonds
  • some only in investment grade bonds
  • others seek to max current income by investing in junk bonds for higher yields
68
Q

corporate bond fund

A
  • higher credit risk than govt issues but still investment grade (safer) or non investment grade (riskier)
69
Q

high yield bond funds

A
  • provide highest yields bc of their increased check risk
  • speculative
70
Q

tax free (tax exempt) bond funds and UITs

A
  • invest in muni bonds or notes that produce income (dividends) exempt from federal income tax
  • appropriate for investors in high marginal tax bracket seeking income
71
Q

US govt funds

A
  • buy securities issued by the US treasury or agency of US govt (Ginnie Mae)
  • ## for investors seeking current income and max safety
72
Q

agency security funds

A
  • not as safe from default risk as US govt funds, is yields are higher than US govt fund yields
73
Q

govt sponsored enterprises (GSEs)

A
  • corporations issued by Congress to foster public purpose - affordable housing
  • not backed by govt
74
Q

principle protected funds

A
  • offer investors a guarantee of principle, adjusted for fund dividends and distributions, on a set future date (maturity) while providing higher returns through investment in higher risk and higher return asset classes - equities
  • guaranteed principle: minus any front end sales charge. backed by insurance policy
  • lock up period: if you sell before the end of the guarantee period (5-10 yrs) you lose the guarantee and potentially lose money
  • hold a mix of stocks and bonds: some zero coupon bonds and debt securities along with equities
  • front end load
  • operating expenses tend to be high
75
Q

money market funds

A
  • no load, open end investment companies that serve as temp holding accts for investors money
  • fund consists of money market securities
  • most suitable for investors who want liquidity
  • interest is distributed as dividend and is computed daily and credit to investor accts monthly
  • check writing privilege - super high liquidity - convert to cash at once
  • NAV is generally fixed at $1for retail money market funds - price of money market shares do not fluctuate due to changing interest rates
  • not guaranteed or protected but FDIC - possible to lose money
  • ## institutional MMF have a stable NAV and are 99.5% govt securities
76
Q

types of ETFs

A
  • unit investment trust (UIT ETF) or open end management company (open end ETF)
  • ETFs register with the SEC under the investment company act of 1940
77
Q

standard ETF

A
  • invests in a specific index
  • traded like stocks on an exchange
  • investor can take advantage of price changes to due the market not sure underlying value of the stocks in the portfolio
  • mostly passive, but some actively managed ETFs where the manager selects assets based on expected performance
  • can be bought on margin on hold short
  • expenses tend to be lower and fees are min, except for brokerage commissions
  • can be tax advantages (some commission free trading now)
  • generally not goos for small investor making regular periodic investments
  • most ETFs are open ended companies
  • no prospectus delivery is required
  • ETFs trade at or near their NAV
  • Uses of ETFs:
    • asset allocation
    • following industry trends
    • balancing a portfolio
    • speculative trading
    • hedging
78
Q

leveraged ETFs

A
  • attempt to deliver a multiple of the return of the benchmark index
  • no limits or rules about amt of leverage
  • high risk, more volatility
  • use derivatives
  • not suitable for all investors
  • reset daily - not for long term investors, only very short time horizons
  • traded on an exchange
79
Q

inverse (reverse or short) funds

A
  • attempt to deliver returns that are the opposite of the index they are tracking
  • can be leveraged
  • bearish attitude
  • not traded on an exchange
80
Q

benefits of including investment company securities in client portfolios

A
  • diversification
  • professional management
81
Q

mutual fund benefits

A
  • choice of objectives, lots of options to suit individual needs/preferences
  • convenient: easy to buy and sell, reinvest, lots of information readily available
  • liquidity: payment must be made in 7 days of the redemption request
  • min initial investment
  • automated investing and withdrawal
  • convenient tax info: form 1099
  • combination privilege in family of funds: combine to reach breakpoint
  • exchange/conversion privilege in a family of funds: investor can convert from one fund to another with incurring additional sales charge (this is a taxable event and any gains/losses are reported at the time of the exchange)
  • leveraged and inverse funds
82
Q

UIT benefits

A
  • income:
    -generally will provide higher income than similar mutual fund portfolio
    - no management fee
    - stability of income since portfolio is fixed
  • liquidity: trustees are obligated to redeem units tendered by investors at the NAV of the unit
  • rolling over proceeds: when the trust terminates, option to invest proceeds in new trust without charge
83
Q

closed end fund benefits

A
  • exchange traded:
    • buy on margin
    • short sell
    • intraday trading
      -liquidity: proceeds from sale 2 bus days after the trade
  • pricing: based on supply and demand - can mean selling at a premium or discount from NAV
  • leverage
84
Q

ETF benefits

A
  • taxation: investor only realizes cap gain/loss upon sale
  • expense ratio: management fees and trading cost/commissions are low
  • portfolio specificity: lots of options
  • exchange traded: prices stay close to NAV, intraday trading, margin and short selling
  • With ETFs, portfolio turnover rate is minimized because they do not have to buy and sell shares within their portfolio to accommodate shareholder purchases and redemptions. This can affect the potential tax consequences. While an ETF can make a capital gains distribution, they generally do not—unlike a mutual fund, which generally would make such distributions on an annual basis. ETFs can be traded like other exchange products using traditional stock trading techniques and are priced by supply and demand. Customers pay commissions, not sales charges.
85
Q

mutual fund risks

A
  • market risk
  • interest rate risk
  • net redemptions: in declining markets where many investors are looking to redeem there might not be enough new share purchase to cover. PM would need to pick assets to liquidate - potential for short term borrowing to cover
  • expense risk: fund might temp reduce fee and then it ends and the cost increase
  • tenure risk: experienced managers mist leave
86
Q

UIT risks

A
  • market risk: since portfolio is fixed, no way to dump losers
  • interest rate risk
87
Q

closed end fund risks

A
  • pricing risk: might end up buying at premium or discount and selling at gain/loss
  • leverage risk
88
Q

ETF risks

A
  • index risk: if security in index underperforms, no way to get rid of it until the index removed the security
  • tracking risk: won’t be equal to index (mostly due to fees and expenses). Recommend an ETF with the highest tracking reliability
89
Q

investment company act of 1940 BOD rule

A
  • BOD: 40% outside directors, 60% interested persons
90
Q

investment company act of 1940- prohibited activities for mutual funds

A
  • prohibited activities for mutual funds:
    • no purchases on margin
    • no joint accounts
    • no short selling
    • no acquiring more then 3% of the outstanding voting securities of another investment company
91
Q

investment company act of 1940- changes in investment policy

A
  • changes in investment policy: need a majority vote of the outstanding voting stock: changes in subclassifications (open to closed), deviation from policy/objectives, changing nature of business
92
Q

investment company act of 1940- size of investment company

A
  • size of investment company: must have a net worth of at least $100,000 to make public offering
93
Q

investment company act of 1940- investment advisory and underwriter contracts

A
  • investment advisory and underwriter contracts: majority of shareholders must approve contracts between the investment company and its investment adviser and contract with principal underwriter. contracts must be in writing and describe all compensation, be approved at least annually by the BOD or majority vote of shareholders if it is be renewed after the first 2 yrs, terminated at any time without penalty by the BOD or majority vote on not more than 60 days written notice . No advisory contract (initial or renewal) can take effect without the approval of the outside/noninterest members of the board.
94
Q

investment company act of 1940- custodian

A
  • must keep assets with a custodian
95
Q

investment company act of 1940- periodic and other reports

A
  • must file annual financial reports with SEC. including audited balance sheet and income statement
  • shareholders must be sent financial info semiannually
96
Q

FINRA rule 2341 - selling dividends

A

-selling dividends is the practice of inducing customers to buy mutual fund shares by implying an upcoming dividend will benefit them. this is prohibited.
- will not benefit them since the NAV will be adjusted due to the dividend

97
Q

FINRA rule 2341 - sales agreement

A
  • firm must have a written sales agreement with the investment company
  • agreement says no member firm may purchase mutual fund shares from a client at a price lower than the NAV next quoted for the shares
  • keeping BD from getting compensation for shares that are quickly redeemed
98
Q

FINRA rule 2341/MSRG rule G-31 - anti-reciprocal rule

A
  • choice of BD must be based on their capabilities, value and quality of services, NOT dollar amt of sales
  • suitability - which funds best fit the client’s obejectioves
    • not selected based on commissions
    • member firm may not knowingly do business with a fund it knows allocate portfolio transaction business on the basis of fund share sales.
  • may not give sales personnel an incentive based on amt of brokerage commissions
  • may not recommend specific investment companies to sales personnel based on brokerage commissions
    • may not grant a salesperson participation in the brokerage commission generated by a transaction if participation is identified with the sale of shares of the investment company
  • may not use sales of shares of an investment company to negotiate the amt of brokerage commission
99
Q

non cash compensation

A
  • retail distribution, mutual fund distributors may pay commissions and concession to member only in cash
  • gifts of material value can’t be worth more $100
  • occasional meals or events
100
Q

gifts rule

A
  • prohibits any member or AP with a member, directly or indirectly from giving anything in value in excess of $100 where such payment is in relation to the business of the recipients employer

Series 7 (19 decks)

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