Chapter 4 – Investment Company Securities Flashcards
When is a mutual fund allowed to buy securities on margin?
A) Only with special permission from the SEC
B) Only after opening a margin account
C) Only in the first 10 trading days of each month
D) Never
Correct Answer:
D) Never
Answer Explanation
Mutual funds are prohibited from selling securities short and also from buying securities on margin or with borrowed funds.
Textbook Reference
Please see textbook section 4.2.3
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Open-end and closed-end company investments share all of the following characteristics EXCEPT
A) Professionally managed by an investment manager subject to registration under the Investment Company Act of 1940
B) The NAV per share is calculated by subtracting the fund liabilities from the fund’s assets and dividing by the number of shares outstanding
C) Shareholders own an undivided interest in all securities with the portfolio
D) They issue a single class of shares
Correct Answer:
D) They issue a single class of shares
Answer Explanation
Open-end companies commonly issue A, B and C shares which reflect different types of sales charges. Closed-end funds issue one type of share class only.
Textbook Reference
Please see textbook section 4.6
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Intra-day trading is available for both
A) Closed-end funds and UITs
B) Closed-end funds and hedge funds
C) Closed-end funds and ETFs
D) Open-end funds and ETFs
Correct Answer:
C) Closed-end funds and ETFs
Answer Explanation
Intra-day trading is available for both closed-end funds and ETFs.
Textbook Reference
Please see textbook section 4.6
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Which two statements correctly compare ETFs and closed-end funds?
I. Both are investment company products
II. Closed-end funds are investment company products; ETFs are not
III. Both have a stable pool of capital
IV. Closed-end funds have a stable pool of capital; ETFs offer shares continuously
A) I and III
B) II and IV
C) II and III
D) I and IV
Correct Answer:
A) I and III
Answer Explanation
Closed-end funds are actually considered a type of ETF by some. These are both classified as closed-end investment companies because they have a stable pool of capital that is raised through their initial public offering.
Textbook Reference
Please see textbook section 4.6
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Which two of the following are characteristics of closed-end companies and their shares?
I. May be purchased on margin
II. Issue multiple share classes
III. May be purchased with stop or limit orders
IV. Are redeemed by the fund
A) II and IV
B) I and IV
C) II and III
D) I and III
Correct Answer:
D) I and III
Answer Explanation
Closed-end funds are traded on exchanges and may be purchased or sold with specified pricing terms through stop and limit orders. They may be purchased on margin, unlike open end company shares. They issue a single class of shares only, and they are not redeemed by the fund. Shareholders must sell their shares on exchanges to liquidate their positions.
Textbook Reference
Please see textbook section 4.3.2.6
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The NAV of a mutual fund share will decrease by the amount of the dividend
A) at the start of trading on the morning the dividend is announced.
B) on the ex-dividend date.
C) when announced by the board of directors of the fund.
D) on the payable date.
Correct Answer:
B) on the ex-dividend date
Answer Explanation
The NAV of the fund will decrease on the ex-dividend date.
Textbook Reference
Please see textbook section 4.2.5
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Money market funds are most appropriate for investors who
A) Are willing to take high degrees of risk.
B) Have no alternative investment choices available to them.
C) Are seeking safety and stability in their investment portfolio.
D) Are looking for tax deferred investments owing to their high tax bracket.
Correct Answer:
C) Are seeking safety and stability in their investment portfolio
Answer Explanation
Money market funds are suitable for investors who are seeking safety and stability in their investment portfolio. These products will often provide a high degree of liquidity.
Textbook Reference
Please see textbook section 4.2.4.2
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In addition to management companies and face-amount certificates, what is the third basic investment company type regulated under the Investment Company Act of 1940?
A) Private Equity funds
B) REITs
C) Direct participation programs
D) Unit Investment Trusts
Correct Answer:
D) Unit Investment Trusts
Answer Explanation
The three basic types of investment companies that are regulated under the Investment Company Act of 1940 are management companies, face-amount certificates and unit investment trusts.
Textbook Reference
Please see textbook section 4.4
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An investor purchased shares of a mutual fund two years ago for $3,500 and has since reinvested dividend distributions of $375 and $325. The investor’s total cost basis in this fund is now
A) $700.00
B) $2,800.00
C) $3,500.00
D) $4,200.00
Correct Answer:
D) $4,200.00
Answer Explanation
The investor’s cost basis in this mutual fund is their original purchase price ($3,500) plus the reinvested dividends ($700), for a total of $4,200. This topic is not explicitly covered in the textbook, but as long as you review this rational for this question you will be covered for exam purposes.
Textbook Reference
Please see textbook section 4.2.5.7
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A customer that purchases closed-end fund shares may pay all of the following EXCEPT
A) Fund expenses
B) Commissions to a sales representative
C) Management Fees
D) 12b-1 fees
Correct Answer:
D) 12b-1 fees
Answer Explanation
Closed-end company shares do not have 12b-1 fees. These are marketing fees incurred by the investor.
Textbook Reference
Please see textbook section 4.3.2.3
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A risk of investing in an international bond UIT that is not commonly associated with other bond UITs is
A) Reinvestment risk
B) Interest rate volatility
C) Currency risk
D) Liquidity risk
Correct Answer:
C) Currency risk
Answer Explanation
International bond UITs hold debt in foreign companies and governments that is denominated in foreign currencies and then converted into U.S. dollars. The dollar does not always hold strong value against other foreign currencies.
Textbook Reference
Please see textbook section 4.4.3.1
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A UIT sells units to investors
A) Through representatives of broker dealers with which selling agreements have been established
B) In private placements only
C) Through the trustee that administers the trust
D) Directly through the sponsor
Correct Answer:
A) Through representatives of broker dealers with which selling agreements have been established
Answer Explanation
The units of UITs are typically distributed by the representatives of broker dealers. A broker dealer must have a selling agreement with the UIT to distribute the UIT’s shares through its representatives.
Textbook Reference
Please see textbook section 4.4.2
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In a unit investment trust the party that is responsible for the trust’s organization is the
A) Trustee
B) Administrator
C) Investment manager
D) Sponsor
Correct Answer:
D) Sponsor
Answer Explanation
A sponsor initiates the formation of a unit investment trust, and is also responsible for the selection of securities that are held in the portfolio.
Textbook Reference
Please see textbook section 4.4.1
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Which of the following features is associated with mutual fund shares but NOT ETFs?
A) Professionally managed pool of securities
B) Securities held by investors represent an equity interest
C) Exchange traded
D) Continuous primary offering
Correct Answer:
D) Continuous primary offering
Answer Explanation
Mutual fund shares are issued through a continuous primary offering, which means shares are available when investors want to purchase them. Closed-end company shares are limited because there is a fixed pool of capital. ETFs are traded on exchanges, mutual fund are not.
Textbook Reference
Please see textbook section 4.6
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An individual that invests in a unit investment trust holds
A) An interest in a variable portfolio of securities that is held for a specified period of time
B) An interest in a variable portfolio of securities that will terminate at the discretion of the sponsor
C) A fixed interest in a portfolio that is held for a specified period of time
D) A fixed interest in a portfolio that will terminate at the discretion of the sponsor
Correct Answer:
C) A fixed interest in a portfolio that is held for a specified period of time
Answer Explanation
Investors in UITs purchase a share of a portfolio of securities that will be held until its date of termination which is defined at the inception of the trust.
Textbook Reference
Please see textbook section 4.4.1.2
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When one of an investor’s goals when purchasing mutual funds is to minimize fees, consideration should be given to
A) Actively managed funds
B) Hedge funds
C) Target date funds
D) Index funds
Correct Answer:
D) Index funds
Answer Explanation
Index funds are appropriate for investors seeking to minimize fees. The other choices will generate more significant fees due to their active management.
Textbook Reference
Please see textbook section 4.2.4.6
Which of the following are true about Exchange Traded Funds?
A) They are marginable
B) They are actively managed
C) They can only be purchased as new issues
D) They cannot be sold short
Correct Answer:
A) They are marginable
Answer Explanation
Exchange Traded Funds are a type of exchange traded products mirrors a stock index. They are not actively managed, they are supervised. ETF’s can be sold short; they can be purchased as new issues or on exchanges in the secondary market, and are marginable.
Textbook Reference
Please see textbook section 4.5.1.2
With regard to the price of closed-end fund shares held by investors which of the following statements is TRUE?
A) Shares are sold at the price calculated at the close of business on that day
B) Shares may be sold at a discount or premium to their NAV
C) Shares are sold at a discount when the securities in the fund have increased in value relative to their NAV
D) The price is set by formula each business day
Correct Answer:
B) Shares may be sold at a discount or premium to their NAV
Answer Explanation
Closed-end company shares trade in the secondary market on exchanges. Their prices are determined by supply and demand and may be priced at a premium or discount to their NAV.
Textbook Reference
Please see textbook section 4.3.2.2
A privilege that applies to mutual fund shareholders and allows them to receive sales charge discounts based on a prior purchase is
A) Conversion privilege
B) A Breakpoint schedule
C) Rights of accumulation
D) Dollar cost averaging
Correct Answer:
C) Rights of accumulation
Answer Explanation
The rights of accumulation privilege allows mutual fund investors to receive breakpoint discounts based on purchases made at a prior time, in different accounts, by other close family members, and for purchase of other funds within the same family. For example, if a mutual fund offers a breakpoint for purchases of $25,000 or more, an investor with shares worth $20,000 could get a reduced sales charge on a $5,000 investment.
Textbook Reference
Please see textbook section 4.2.5.6
A mutual fund sponsor receives a request for redemption just after market close and redeems the shares at the NAV just calculated at the close. Which of the following statement is TRUE?
A) Since the order was received after market close, the redemption should have taken place at market opening on the next business day
B) This is standard practice for the redemption of fund shares since redemption must be made on the day of request
C) This is a prohibited practice known as late trading
D) This is a permitted practice known as late trading
Correct Answer:
C) This is a prohibited practice known as late trading
Answer Explanation
This is an example of the prohibited practice of late trading. Mutual fund redemptions are to be made following the forward pricing convention, which means they are to receive the next calculated price. An information advantage may be available if forward pricing is not followed, and a number of large fines have been assessed on firms that engaged in this practice.
Textbook Reference
Please see textbook section 4.2.6
Closed-end funds are subject to regulation by which of the following?
I. The Securities Act of 1934
II. The Investment Company Act of 1940
III. The Investment Advisors Act of 1940
A) I and II only
B) II and III only
C) I, II, and III
D) I and III only
Correct Answer:
C) I, II, and III
Answer Explanation
Closed-end companies are subject to regulation under all major securities Acts, including the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisors Act of 1940. The Securities Act of 1933 also applies when the closed-end fund is first issued.
Textbook Reference
Please see textbook section 4.1
An investor that wishes to liquidate ETF shares will receive cash
A) Equal to the market value of the shares at the end of the trading day
B) Equal to the NAV
C) In the amount of the market value of the shares at the time the order is executed
D) Equal to the POP
Answer Explanation
ETF shares trade on exchanges, typically the NYSE or NASDAQ. Investors receive the market price of their shares, less any transaction charges, when shares are liquidated. The price of the shares could be a discount or premium to the NAV of the fund’s shares.
Textbook Reference
Please see textbook section 4.5.1.2
Which type of investment company product issues a single class of shares only and trades on the market at a discount or premium to its NAV?
A) Open end company
B) Both closed-end companies and UITs
C) Closed-end company
D) Unit investment trust
C) Closed-end company
Answer Explanation
Closed-end companies issue a single share class of securities only; mutual funds commonly issue Class A, B and C shares. Closed-end shares trade on exchanges at a discount or premium to NAV; UITs are redeemed by the trust.
Textbook Reference
Please see textbook section 4.3.2.2
An investor holding a face-amount certificate owns an instrument most similar to a(n)
A) bond
B) ETF
C) Share of common stock
D) ADR
Answer Explanation
A face-amount certificate is a type of investment company that issues debt securities, obligating the issuer to pay a fixed amount at a specified date.
Textbook Reference
Please see textbook section 4.1
The NAV of mutual fund shares will increase in which of the following circumstances? A) Outstanding shares are redeemed B) The fund receives interest from bonds that are held within the portfolio C) Capital gains of the fund are distributed D) Shareholders reinvest dividend and capital gains distributions
B) The fund receives interest from bonds that are held within the portfolio Answer Explanation The NAV of mutual fund shares increases when the value of securities held in the portfolio increases, when the portfolio receives distributions of dividends or interest from securities it owns, or when it sells portfolio securities at a profit. There is no change to NAV when new shares are issued or when shares are redeemed. The NAV of shares falls when the fund makes dividend or capital gains distributions. Textbook Reference Please see textbook section 4.2.4
An investor is interested in an investment opportunity in which he can have an ownership interest in a specific portfolio of bonds for the next 20 years, and does not have to pay high management fees. Which of the following investments is most suitable? A) A structured note B) Units in a bond UIT C) A closed end bond fund D) A fixed income mutual fund
B) Units in a bond UIT Answer Explanation Unit investment trusts hold a specified portfolio of investments for a defined period that is established at the creation of the trust. Because their portfolios are fixed, investors are not subject to high management fees. Textbook Reference Please see textbook section 4.4.3
With respect to raising capital, closed-end funds may issue A) bonds only B) Common stock, bonds and preferred stock C) common stock only D) common and preferred stock only
B) Common stock, bonds and preferred stock Answer Explanation Closed-end funds may issue ‘senior securities’, such as preferred stock and bonds, as opposed to open-end funds which may only issue common stock to raise capital. Textbook Reference Please see textbook section 4.3.2.5
All of the following statements regarding the organization of a unit investment trust are true EXCEPT A) An investment manager is hired to actively manage the trust assets B) The securities to be held in the portfolio are selected to meet a specified investment objective C) The Trust Indenture is the document that initiates the formation of the trust D) The trust must register under the Securities Act of 1933
A) Answer Explanation A unit investment trust is not actively managed. The trust securities are selected by the trust sponsor and held with few exceptions until the trust is terminated. Textbook Reference Please see textbook section 4.6
An investment company where the purchase and redemption price are the same is a A) No-load fund B) Index fund C) Diversified fund D) Value fund
A) No-load fund Answer Explanation A “no-load” fund is one which is sold to the public at the NAV, without any sales charge being added. Consequently, the NAV & POP would be the same in this instance. Textbook Reference Please see textbook section 4.2.5.2
Which two of the following statements describe closed-end funds? I. They are a continuous primary offering II. There is a fixed number of shares III. Shares are liquidated through exchange trading IV. Shares are redeemed by the fund A) I and III B) I and IV C) II and III D) II and IV
C) II and III Answer Explanation Closed-end fund shares issue a limited number of shares through IPOs. To receive cash for their shares, investors sell closed-end company shares in secondary market transactions on exchanges. They are not redeemed by their issuer, like mutual fund shares. Textbook Reference Please see textbook section 4.3
A mutual funds are typically prohibited from engaging in which two of the following activities? I. Short selling of securities II. Investing in senior equity and debt securities III. Distributing its own securities IV. Borrowing funds to purchase securities A) II and IV B) II and III C) I and IV D) I and III
C) I and IV Answer Explanation Typically, mutual funds are prohibited from purchasing securities on margin and short selling. Additionally, mutual funds cannot issue preferred stock or debt securities, but they are permitted to invest in them within their portfolios. Textbook Reference Please see textbook section 4.2.3
All of the following practices are prohibited in the sales of mutual fund shares EXCEPT A) An investor is encouraged to engage in a trading strategy that involves regularly purchasing and redeeming shares within a short time frame to take advantage of share pricing inconsistencies B) A redemption request that is received today is processed at the NAV calculated at the previous day’s close C) A registered representative recommends that an investor make a slightly larger investment to qualify for a breakpoint D) An investor is encouraged to purchase shares in a fund just before the ex-dividend date to receive the dividend distribution
C) Answer Explanation Breakpoints allow investors to receive a discount on the sales charge based on the dollar amount invested. Registered representatives are required to disclose the existence of breakpoints to clients. Late trading is the prohibited practice of redeeming or purchasing shares at a price previously calculated instead of following the forward pricing rule. Market timing, or executing short term purchase and sales of mutual fund shares is also a prohibited practice. Because of their fee structures, mutual funds should be recommended as a long-term investment. Encouraging the purchase of shares just prior to a dividend distribution is called “selling dividends” and subjects the investor to a taxable event and a reduction in share value, since the NAV of fund shares falls when a dividend is distributed. Textbook Reference Please see textbook section 4.2.6
An investor plans to purchase a home in the next 6 – 12 months and would like to invest funds for a down payment in a mutual fund. Which of the following choices is most suitable? A) A money market fund B) A balanced fund C) A real estate fund D) A U.S. government bond fund
A) A money market fund Answer Explanation Money market funds are appropriate for investments that need to be liquidated for their full value in a short time frame. Although not guaranteed, the value of each share has been held constant at $1, so investors in money market funds do not lose principal and can liquidate their shares for their full value plus interest that was earned. Textbook Reference Please see textbook section 7.4
When comparing ETFs and closed-end funds, which two of the following statements are TRUE? I. ETFs typically trade at a deeper discount or higher premium from NAV II. Closed-end fund shares typically trade at a deeper discount or higher premium III. Closed-end funds typically experience more volatility then ETFs IV. ETFs typically experience more volatility than closed-end funds A) I and III B) II and III C) I and IV D) II and IV
B) II and III Answer Explanation Closed-end funds can commonly trade at a discount or premium of 10%– 20% of their NAV, while ETFs are normally trading within 1% of their NAV. There is much greater market volatility in the price of closed-end shares than in ETFs. Textbook Reference Please see textbook section 4.5.1.2
When a UIT reaches the termination date specified at its creation, the trust A) Has a new offering of units B) Is sold and proceeds are distributed to unit holders C) Can refile with the SEC for a subsequent primary offering D) Is dissolved and no longer active
D) Answer Explanation A UIT is created for a specified period of time. Its termination date is established at the time the trust is created, and the trust is dissolved when that date is reached. Textbook Reference Please see textbook section 4.4.1.2
The responsibility of the sponsor of a unit investment trust includes which of the following? I. Selection of the securities for the trust II. Organizing the formation of the trust III. Tax reporting for the trust IV. Recordkeeping for the trust A) II and III B) II and IV C) I and II D) I and IV
C) I and II Answer Explanation The sponsor of a UIT organizes the trust and is responsible for the selection of the portfolio securities. The trustee handles administrative functions, including the recording keeping, accounting and tax reporting duties. Textbook Reference Please see textbook section 4.4.1
Closed-end funds are subject to regulation by which of the following? I. The Securities Act of 1934 II. The Investment Company Act of 1940 III. The Investment Advisors Act of 1940 A) I and II only B) I, II, and III C) I and III only D) II and III only
B) I, II, and III Answer Explanation Closed-end companies are subject to regulation under all major securities Acts, including the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisors Act of 1940. The Securities Act of 1933 also applies when the closed-end fund is first issued. Textbook Reference Please see textbook section 4.1
An individual enters an online order for the purchase of mutual fund shares directly from the fund’s sponsor. He will purchase shares at the A) POP price calculated on that morning’s market opening B) POP price next calculated C) NAV price calculated on that morning’s market opening D) NAV price next calculated
B) POP price next calculated Answer Explanation Mutual fund shares are purchased and redeemed at the next calculated price – the concept of forward pricing. The customer will purchase shares at the public offering price next calculated (POP). Shares are redeemed at the next calculated NAV. Textbook Reference Please see textbook section 4.2.5.1
Investment Companies Flashcards
An investor wants to exchange shares of one fund with shares of another fund that is within the same family of funds. Which of the following is NOT an important consideration when making such an exchange?
[A] The fund’s investment objectives
[B] The investment risk profile of the fund
[C] Tax consequences
[D] The sales load of the new fund
[D] The sales load of the new fund
When doing a conversion or switching of shares within the same family there would generally not be any sales load imposed; therefore, sales load would not be a consideration.
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A client increases their investment amount from $49,000 up to $50,000 after hearing about a reduction in sales charge related to quantities over $49,999. Which of the following would be TRUE of this scenario?
[A] This would describe a broker-dealer reducing their commissions.
[B] This would describe unethical behavior, since such discounts are not permitted.
[C] This would describe an agent at the firm attempting to increase their commission with higher amounts being invested.
[D] This would describe a breakpoint offered by the mutual fund.
[D] This would describe a breakpoint offered by the mutual fund.
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Which of the following types of Funds BEST describe the Fund which uses leverage, sells short, buys puts and calls, and undertakes other speculative practices to maximize capital gains.
[A] Sector Fund (Specialized Fund)
[B] Money Market Fund
[C] Aggressive Growth Fund
[D] Balanced Fund
[C] Aggressive Growth Fund
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When an investor buys mutual fund shares and later redeems the shares to the fund without having to pay a Sales Load, the fund is known as which of the following?
[A] A Front-end Load Fund
[B] A No-Load Fund
[C] A 12b-1 Fee Fund
[D] A fee free fund
[B] A No-Load Fund
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Which of the following types of investments should be used as a long-term investment and not for short-term trading purposes?
[A] equity options
[B] mutual funds
[C] treasury bills
[D] certificates of deposit
Due to the Sales Load paid when purchasing a mutual fund, such investments should only be made as long-term investments.
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An “exchange privilege” offered by a group of mutual funds allows the investor to
[A] sell their shares on the New York Stock Exchange.
[B] exchange shares of an open-end fund for an ETF.
[C] exchange shares of one fund in the group for another different fund in the group at a reduced or no sales charge.
[D] withdraw cash from investments in fund shares without losing the option of continuing to reinvest dividends and capital gains.
[C] exchange shares of one fund in the group for another different fund in the group at a reduced or no sales charge.
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The term “net asset value plus sales charge” is synonymous with
[A] bid price.
[B] ask price.
[C] redemption price.
[D] discount price.
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Crossfire Capital is a business development company (BDC) that is about to issue new shares to the public. Which of the following is true regarding the prospectus delivery requirement to the investor?
[A] The investor must receive a hard copy of the prospectus.
[B] BDCs must provide a link to the prospectus and a hard copy.
[C] Prospectus delivery is generally not required for BDC unless the offering is above $1 billion.
[D] Providing a link to the prospectus satisfies delivery requirements.
[D] Providing a link to the prospectus satisfies delivery requirements.
Business development companies (BDCs) are a type of closed-end funds. Closed-end funds are no longer required to deliver hard copies of the final prospectus to investors. There is no minimum threshold that triggers if a prospectus must be delivered or not. Delivery is satisfied when the final prospectus is filed with the SEC and the fund provides investors with access to the prospectus via the Internet. However, a hard copy must be provided if the investor requests it.
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Which of the following is NOT a characteristic of a money market mutual fund?
[A] The total return must be comprised of 50% dividends and interest and 50% capital gains.
[B] The portfolio contains short-term instruments.
[C] Investments of the fund have very low credit risk.
[D] A minimum of 95% of the assets of the fund must be rated in the top two categories of a well-known ratings service.
[A] The total return must be comprised of 50% dividends and interest and 50% capital gains.
A money market fund’s portfolio contain short-term instruments (an average weighted maturity of 90 days or less), offer minimal credit risk, and invest a minimum of 95% of fund assets in securities that are rated in the top two categories of a NRSRO (Nationally recognized statistical ratings organization). There is NO requirement for percentage of income which must be earned from income. Also, given the short-term nature of the investments in the portfolio it is unlikely there will be capital gains.
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Under the Investment Company Act of 1940, Which of the following is NOT an investment company?
[A] A unit investment trust
[B] A variable annuity
[C] A mutual fund
[D] A face amount certificate
[B] A variable annuity
There are three types of investment companies:
face amount certificates
unit investment trusts
management companies (open-end and closed-end funds).
While variable annuity separate accounts are regulated under the Investment Company Act of 1940, they are not considered to be an investment company.
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An investment company that only offers non-redeemable shares is which of the following types?
[A] Variable Life company
[B] An open-end investment company
[C] A Whole Life company
[D] A closed-end investment company
[D] A closed-end investment company
Closed-end investment company shares trade in the open market in a manner similar to common stock. These shares would not be redeemable to the investment company as is the case with open-end investment companies. Once the closed-end fund shares are issued the investor can only “redeem” them by selling them on an exchange.
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In which of the following situations would the delivery of a prospectus be required?
[A] A long-standing mutual fund sells redeemable shares on a continuous basis to investors.
[B] A corporation with stock that was issued several years ago sells treasury stock to investors in the secondary market.
[C] An investor buys shares of an exchange-listed, closed-end fund from another investor.
[D] An options trader closes out an existing short position by buying an option.
[A] A long-standing mutual fund sells redeemable shares on a continuous basis to investors.
Of the choices listed, the only choice that requires the delivery of a prospectus would be the sale of mutual fund shares on a continuous basis to investors. Remember that mutual funds are open-end investment companies, Because mutual fund shares are redeemable and each issued share is considered “new,” mutual funds are required to deliver a prospectus to purchasers.
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Which of the following terms are synonymous when referring to open-end investment company shares?
[A] Net asset value and redemption price
[B] Bid and offering price
[C] Ask and net asset value
[D] Net asset value and sales price
[A] Net asset value and redemption price
On an open end fund:
NAV = redemption price = Bid
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Which of the following is the BEST description of the prospectus of a mutual fund?
[A] It is the best location to find current market prices for the fund and a listing of all securities contained within the fund.
[B] A document that includes details about the fund including investment objective, performance, sales load structure, fee structure, level of risk, as well as who will manage the fund and how it will be managed.
[C] A document containing all relevant accounting information for the fund up to the end of the most recent trading day.
[D] It is the best location to find a listing of all current investors who own shares of the mutual fund and the volume of shares held for each investor.
[B] A document that includes details about the fund including investment objective, performance, sales load structure, fee structure, level of risk, as well as who will manage the fund and how it will be managed.
The prospectus for a mutual fund is the best location to find relevant information about the fund such as the investment objective of the fund, performance, sales load, fee structure, risk level, and information on who and how the fund is managed. It will not contain specific pricing information for the fund or a listing of all securities within the fund, because these items will change daily. Though some accounting information may be found in the prospectus, it would not be current up to the most recent trading day. Privacy laws generally prohibit disclosure of shareholder information, so a prospectus will not have a listing of all current investors and the volume of shares held.
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Which of the following is TRUE of open-end investment companies?
[A] Shares are issued and redeemed daily.
[B] A fixed number of shares is issued and then publicly traded.
[C] Upon initial issuance, the investor must be provided with a prospectus; secondary market transactions do not require a prospectus.
[D] The share price at which an investor can sell the fund is based on supply and demand.
[A] Shares are issued and redeemed daily.
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The Net Asset Value of mutual fund shares is best defined as the
[A] closing market value of all the securities in the fund’s portfolio plus any interest or dividend income received on the securities in the portfolio.
[B] value of fund shares based on the average price calculated over the time the shares were owned by an investor.
[C] value determined by market-makers who make a market in the fund shares.
[D] a reflection of the best prices available during that specific trading day.
[A] closing market value of all the securities in the fund’s portfolio plus any interest or dividend income received on the securities in the portfolio.
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A client increases their investment amount from $49,000 up to $50,000 after hearing about a reduction in sales charge related to quantities over $49,999. Which of the following would be TRUE of this scenario?
[A] This would describe a broker-dealer reducing their commissions.
[B] This would describe unethical behavior, since such discounts are not permitted.
[C] This would describe an agent at the firm attempting to increase their commission with higher amounts being invested.
[D] This would describe a breakpoint offered by the mutual fund.
[D] This would describe a breakpoint offered by the mutual fund.
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Open-end investment companies are regulated by all of the following EXCEPT:
[A] The Securities Act of 1933.
[B] The Investment Company Act of 1940.
[C] The Trust Indenture Act of 1939.
[D] Securities laws in the state in which the fund is sold.
[C] The Trust Indenture Act of 1939.
The Trust Indenture Act of 1939 regulates corporate debt issues.
All of the following represent fees which could be charged by a mutual fund except?
[A] Commission
[B] Sales Load
[C] 12b-1 Fee
[D] Sales Charges
Commissions are generally charged when investors trade shares of stock and not charged on mutual fund transactions.
Assume that interest rates have remained stable while stock prices have been declining. An investor is most concerned about the loss of principal when investing and asks his registered representative whether a balanced fund or a growth fund would provide better preservation of capital. The RR should tell the customer that the
[A] balanced fund is better because the debt securities and preferred stocks in the portfolio will provide downside protection in this scenario.
[B] growth fund is better because of the greater potential for gains.
[C] balanced fund is better because of the inclusion of blue chip stocks in the portfolio.
[D] growth fund is better because such funds typically hold a diverse portfolio of AAA-bonds.
[A] balanced fund is better because the debt securities and preferred stocks in the portfolio will provide downside protection in this scenario.
A balanced fund holds common stock, preferred stock, and bonds. It is a very conservative type of fund because of this diversification of asset classes. It typically performs better than a pure stock fund in a declining market. A growth fund is typically a pure stock fund, often comprised of small capitalization stocks.
A mutual fund investor is seeking aggressive growth. Which of the following funds would be most appropriate for the customer to invest in?
[A] Balanced Fund.
[B] Hedge Fund.
[C] Money Market Fund.
[D] Sector Fund.
Balanced Funds and Money Market Funds are relatively conservative investments for Investment Companies. A Sector Fund is one that invests in a specific industry of geographic area (e.g., biotechnology, gold mines, European countries). A Hedge Fund provides a hedge against market moves by having long and short positions.
Which of the following is NOT a characteristic of mutual funds?
[A] Professional management
[B] Diversification
[C] Special services including dividend reinvestment plans and periodic withdrawals
[D] Highly liquid secondary markets
[D] Highly liquid secondary markets
All are characteristics of mutual funds except highly liquid secondary markets. Mutual funds are open-end investment companies and issue redeemable shares. If investors want to sell their shares they are not sold in the secondary market but are redeemed back to the investment company that issued the shares.
How is a hedge fund similar to an investment company?
[A] They have the same regulations.
[B] They are redeemable and are priced at the end of every business day.
[C] They have a managed portfolio of investments.
[D] They can be sold to the general public
[C] They have a managed portfolio of investments.
Both a hedge fund and an investment company are comprised of a managed portfolio of investments. A hedge fund is not heavily regulated as compared to an investment company. Investment companies and hedge funds are redeemable, however, investment companies are priced at the end of every business day and hedge funds are priced monthly, quarterly, or annually. Investment companies can be offered to the general public while hedge funds are limited to accredited investors, qualified clients, and semi-affluent investors.
Diane is looking for a mutual fund that she can invest in that would provide her with appreciation in value but wants little or no income since she does not want to be pushed into the next tax bracket and increase her tax liability. Which of the following would be an appropriate recommendation for Diane?
[A] A Blue Chip Common Stock Fund
[B] A Utility Fund
[C] A Growth Stock Fund
[D] A Bond Fund
[C] A Growth Stock Fund
Of the choices offered, a Growth Fund would be the most appropriate choice since growth stocks pay little or no dividend and are expected to provide capital appreciation. Both the Blue Chip Fund and the Utility Fund would be expected to pay dividends. The Bond Fund would also be expected to pay dividends based on the interest income to the fund.
Which of the following are TRUE concerning a money market fund? I. The rate of return is generally two points under the prime rate. II. The owners are shareholders. III. The client is subject to substantial penalties for early withdrawal. IV. A prospectus must precede or accompany an original purchase. [A] I and III [B] II and IV [C] II and III [D] I and IV
[B] II and IV
Dividends are paid by all of the following types of securities EXCEPT: [A] American Depository Receipts [B] Unit Investment Trusts [C] Money Market Funds [D] Preferred Stock
[B] Unit Investment Trusts Unit Investment Trusts pay investors interest – not dividends.
A Letter of Intent (LOI) is an agreement that is signed by [A] the purchaser of mutual fund shares indicating the intent to purchase a large quantity of shares over a short-term period of time and it offers the purchaser the ability to receive a breakpoint, or reduced sales load. [B] the purchaser of mutual fund shares indicating the intent to purchase and accumulate value in relation to mutual fund shares, potentially qualifying for reduced sales loads on future purchases. [C] a broker-dealer that intends to offer shares of a mutual fund to their customers. [D] a customer of a broker-dealer who intends to open an account at the broker-dealer firm, but does not yet have the capital available for an initial deposit.
[A] the purchaser of mutual fund shares indicating the intent to purchase a large quantity of shares over a short-term period of time and it offers the purchaser the ability to receive a breakpoint, or reduced sales load. A letter of intent (LOI) is an agreement that allows for a breakpoint to be reached with the total funds invested over a specified period of time (up to 13 months). Once the total investment reaches the amount agreed upon in the LOI, the investor receives a breakpoint on all funds invested. A Rights of Accumulation would be used if an investor intended to buy and accumulate value of mutual fund shares and hoped to achieve a breakpoint in relation to this accumulated value. Broker-dealers have selling arrangements with mutual fund offerors, but would not sign a letter of intent. If a customer wishes to open an account but does not yet have the capital available to do so, the firm would just tell the customer to wait until the funds are available; there is no LOI in this context or scenario.
When market prices are rising, which of the following funds would be expected to show the least amount of appreciation? [A] Diversified Common Stock Fund [B] Specialized Fund [C] Balanced Fund [D] Blue Chip Fund
[C] Balanced Fund Because a balanced fund includes investment in Common Stock, Preferred Stock and Bonds, it would show the least amount of appreciation.
Open-end investment companies do not list on national exchanges because they [A] qualify for listing on the OTC market only [B] are continuously being offered as new issues by the fund [C] require 100% shareholder approval [D] are wholly owned and traded by the underwriter
[B] are continuously being offered as new issues by the fund Mutual funds or open-end investment companies offer redeemable shares only. They do not offer shares that are publicly traded. Therefore, the fund is always issuing new shares to the public and redeeming shares that are sold back to the fund and would not have shares listed on a national exchange.
The chief reason for offering multiple mutual fund share classes is to allow [A] the RR to decide which fund investment objective would be best for the customer. [B] the RR to select funds that only charge back-end loads. [C] investors to match their financial needs and choose a fee schedule that falls in line with those needs. [D] investors to trade and exchange shares from one fund class for shares of another fund class.
[C] investors to match their financial needs and choose a fee schedule that falls in line with those needs. The primary reason that investors are offered multiple share classes of a mutual fund is to accommodate the shareholder’s needs and allow the investor to choose a structure of fees that best suits those needs. All of the other reasons are either inappropriate or incorrect.
A global fund would be described as a fund which invests in which of the following? [A] Securities that are issued by nearly every country in the world [B] Stocks that are issued by both foreign and U.S. companies [C] Stocks that are issued only by foreign companies [D] Stocks that are issued only by U.S. companies
[B] Stocks that are issued by both foreign and U.S. companies Global funds generally include securities issued by both foreign and U.S. companies, whereas international funds include foreign securities only.
Joe calls his registered representative and is interested in investing in a new business development company. Joe is generally a conservative investor. What should the RR say to Joe? [A] The RR should tell Joe that the investment choice is good because it satisfies his investment objectives. [B] The RR should tell Joe that the investment choice is not a good choice because investing in a new business development company requires high risk tolerance. [C] The RR should tell Joe that the investment choice is suitable and has the potential for substantial appreciation. [D] The RR should tell Joe that the investment choice is unsuitable but could be a good gamble.
[B] The RR should tell Joe that the investment choice is not a good choice because investing in a new business development company requires high risk tolerance. Investing in a New Business Development Company requires that the investor have a “high risk tolerance level”. Since Joe is generally a “conservative” investor, the RR should advise Joe that the investment is NOT a good choice.
All of the following fall under the definition of a registered investment company EXCEPT [A] a growth and income fund [B] a separately managed account [C] the separate account of a variable annuity [D] a money market fund
[B] a separately managed account A growth fund and an income fund are both mutual funds and therefore are investment companies. The sub-account of a variable annuity must register under the Investment Company Act of 1940 and is considered to be an investment company registered under the Act. A separately managed account is a professionally managed portfolio of securities but the securities are directly owned by the account owner (the customer) therefore they are NOT classified as investment companies.
Which of the following documents contains key information about a mutual fund including the fund’s investment objectives, fee table and tax information which are used to initially acquaint investor with fund information? [A] The Funds Balance Sheet [B] The Funds Summary Prospectus [C] The Funds Cash Flow Statement [D] The Funds Official Statement
[B] The Funds Summary Prospectus A mutual funds is able to satisfy its statutory prospectus delivery requirements by initially delivering to the client the fund’s Summary Prospectus. The Summary Prospectus includes the fund’s investment objectives, fee table, investment risks, management, tax information. The Summary Prospectus is only a few pages long as compared to the full Statutory Prospectus. The Statutory Prospectus must be available online.
An open-end investment company (mutual fund) has increased in value because of a rise in the market. This would be best characterized as [A] a capital gain [B] a profit. [C] appreciation. [D] accretion.
[C] appreciation.
A numerical measure of how much the return on a mutual fund has varied regardless of cause, from the historical average return of the fund is known as: [A] current yield. [B] standard deviation. [C] beta or alpha. [D] dividend payout ratio.
[B] standard deviation. The standard deviation is a numerical measure of how much the return on a mutual fund has varied regardless of cause, from the historical average return of the fund. The greater the deviation the greater the risk.
An investor seeking a high yield asks his registered representative which type of fund to invest in. The registered representative should recommend which one of the following? [A] Balanced fund [B] Dual Purpose fund [C] Growth fund [D] Income fund
[D] Income fund An income fund’s objective is to maximize current income (high yield).
Which of the following would NOT be able to qualify for a quantity discount in relation to the purchase of mutual fund shares? [A] An individual investor [B] The trustee of a trust [C] An investment club established by members of a golf club [D] A custodian handling the account of a minor
[C] An investment club established by members of a golf club Investment clubs are groups of persons pooling money together, and, therefore, would not qualify for quantity discounts.
A Hedge Fund investment would be best suited for which of the following types of investors? I. Senior Investors II. Accredited Investors III. Aggressive Investors IV. Qualified Investors [A] I & II [B] II & III [C] III & IV [D] II & IV
[D] II & IV Hedge Funds are investments best suited for affluent investors such as Accredited or Qualified Investors since they take on a large amount of risk by using long and short positions, leverage, and derivatives. Hedge Funds would NOT be suitable for Senior Investors. Simply because an investor is “aggressive” does not satisfy the requirement of being either a qualified or accredited investors, you would need to know more information about a customer than simply that they are aggressive.
An investor wants to exchange shares of one fund with shares of another fund that is within the same family of funds. Which of the following is NOT an important consideration when making such an exchange? [A] The fund’s investment objectives [B] The investment risk profile of the fund [C] Tax consequences [D] The sales load of the new fund
[D] The sales load of the new fund When doing a conversion or switching of shares within the same family there would generally not be any sales load imposed; therefore, sales load would not be a consideration.
In which of the following situations would the delivery of a prospectus be required? [A] A long-standing mutual fund sells redeemable shares on a continuous basis to investors. [B] A corporation with stock that was issued several years ago sells treasury stock to investors in the secondary market. [C] An investor buys shares of an exchange-listed, closed-end fund from another investor. [D] An options trader closes out an existing short position by buying an option.
[A] A long-standing mutual fund sells redeemable shares on a continuous basis to investors. Of the choices listed, the only choice that requires the delivery of a prospectus would be the sale of mutual fund shares on a continuous basis to investors. Remember that mutual funds are open-end investment companies, Because mutual fund shares are redeemable and each issued share is considered “new,” mutual funds are required to deliver a prospectus to purchasers.
Mutual funds must send financial reports to their shareholders at least [A] with each trade confirmation which contains a link to the reports [B] Upon request by the customer [C] Semi-annually [D] Annually
[C] Semi-annually Sections 13(a) and 15(d) of the Securities Exchange Act of 1934 require funds to send financial reports to shareholders at least semi-annually (once every six months).
All of the following would be considered to be a benefit to investors purchasing ETNs EXCEPT: [A] No annual tax since ETNs do not pay interest or dividends [B] Investor fees accumulate annually [C] No tracking errors [D] Participation in market sectors ordinarily not accessible to many investors
[B] Investor fees accumulate annually ETNs provide investors with the ability to invest in market sectors that would ordinarily be deemed unsuitable including commodities, currencies, emerging markets, and strategies. Since the investor who owns an ETN with the issuing bank they are not subject to tracking error as with an ETF. Since ETNs do not pay annual interest or dividends there is no annual tax and the participation in the gains would later be treated as a capital gain or loss to the investor, generally long-term. Investor fees would NOT be considered a “benefit” to the investor purchasing an ETN.
Which of the following is correct regarding passive versus active ETFs (Exchange-Traded Funds)? [A] Active ETFs are created to mimic the underlying benchmark index. [B] Passive ETFs typically have higher volatility. [C] Passive ETFs typically have higher expenses. [D] Active ETFs seek to outperform the underlying benchmark index.
[D] Active ETFs seek to outperform the underlying benchmark index. ETFs can be passive or active. Passive ETFs are typically created to mimic the components of the index or benchmark they track so that trading is minimal and the returns match those of the index being tracked. Active ETFs, however, intend to outperform their index by using the services of a portfolio manager.
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