Chapter 9 - Investment Companies and Other Products

Question 1

How investment companies are organized

Answer 1

An investment company is organized as either a corporation or as a trust.

Question 2

Securities Act of 1933

Answer 2

Requires the investment company to register with the SEC and to give all purchasers a prospectus.

Question 3

Investment Company Act of 1940

Answer 3

Authorize the SEC to regulate UITs and manage investment companies (closed-end and open-end) plus variable products. Sets forth guidelines on how investment companies must operate.

Question 4

Open-end mutual funds

Answer 4

An open-end company offers new shares to any investor who wants to invest. This is known as a continuous primary offering.

The capitalization of the open-end fund is unlimited and may raise as much money as investors are willing to put in.

There is no secondary market for open-end mutual fund shares.

Full and fractional shares.

NAV + SC = POP

Question 5

Closed-end mutual funds

Answer 5

A closed-end fund offers common shares to investors through an initial public offering.

Its capitalization is limited to the number of authorized shares that have been approved for sale.

Shares of the closed-end fund will trade in the secondary market in investor-to-investor transactions on an exchange or over-the-counter the.

Full shares only.

Question 6

Exchange Traded Funds (ETFs)

Answer 6

Is an equity security represents an ownership interest in a basket or portfolio of underlying securities. Many are designed to track the performance of an underlying index, such as the S&P 500 or the Dow Jones industrial average.

Question 7

Exchange-Traded Notes (ETNs)

Answer 7

Sometimes known as equity blank notes or index link notes.

Base maturity payment on the performance of an underlying security or a group of securities such as an index. They do not make coupon or interest payments to investors during the time the investor owns the ETN.

Question 8

Diversified mutual fund (75-5-10)

Answer 8

Must meet 75-5-10 test:

75% of the funds assets must be invested in securities of other issue or’s. Cash and cash equivalents are counted as part of the 75%.

The investment company may not invest more than 5% of its assets in any one company.

The investment company may not own more than 10% of any companies outstanding voting stock.

Question 9

Registration requirements with the SEC

Answer 9

To register with SEC, a company must have:

• Minimum net worth of $100,000
• At least 100 shareholders
• Clearly define investment objectives

Note: an investment company may be allowed to register without having 100 shareholders and without a net worth of $100,000 if it can meet these requirements within 90 days.

Question 10

Investment Companies are prohibited from:

Answer 10

An investment company is prohibited from:

• Taking over or controlling other companies
• Acting as a bank or a savings and loan
• Receiving commission for executing orders or for acting as a broker
• Continuing to operate with less than 100 shareholders or less than $100,000 net worth

Question 11

Investment Company components

Answer 11

Investment companies have several different groups that serve specialized functions. They are:

• The board of directors
• The investment adviser
• The custodian bank
• The transfer agent

Question 12

Investment company board of directors

Answer 12

Overseas the company’s president and other officers who run the day-to-day operations of the company.

Defines the investment objectives.

Hires the investment advisor, custodian bank, and transfer agent.

Determines what type of funds to offer such as growth or income.

All directors must serve a minimum of one year and may not serve more than five years without being reelected. The investment company act of 1940 requires that at least a majority of the board be non-interested persons.

Question 13

Investment company investment adviser

Answer 13

Hired by the company’s Board of Directors, the investment advisor is a company, not a person.

The investment advisor must determine the tax consequences of distributions to shareholders and ensure that the fund’s investment strategies are in line with the stated investment objectives.

Question 14

Investment company custodian bank

Answer 14

The custodian bank, or the exchange member broker dealer that has been hired by the investment company, physically holds all of the fund’s cash and securities.

Question 15

Investment company transfer agent

Answer 15

The transfer agent for the investment company handles the issuance, cancellation, and redemption of fund shares.

Question 16

Distribution of mutual fund shares

Answer 16

Most beautiful fonts do not sell their own shares directly to investors. The distribution of shares is the responsibility of the underwriter, also known as the sponsor or distributor. They receive a fee in the form of a sales charge for the shares it distributes.

Net Asset Value + Sales Charge = Public Offering Price
(NAV + SC = POP)

Question 17

Mutual Fund Prospectus

Answer 17

The prospectus is the fund’s full disclosure document.

A summary prospectus that contains past performance data is known as an advertising prospectus.

A mutual fund prospectus:

• Should be updated every 12 months
• Must be updated every 13 months
• May be used by a representative for up to 16 months
• Should be discarded after 16 months

Question 18

Mutual Fund audit report and update

Answer 18

Audit report: annually

Update report: semiannual

Question 19

Money Market Funds guidelines

Answer 19

The prospectus must clearly state on its cover that the fund is not insured or guaranteed by the US government.

Securities in the portfolio may have a maximum maturity of 13 months.

The average maturity for securities in the portfolio may not exceed 90 days.

No more than 5% of the funds assets may be invested in any one issuer’s debt securities.

Question 20

NAV calculation

Answer 20

NAV = Assets - Liabilities

NAV per share:

Total NAV / total # of shares

Question 21

Changes in NAV

Answer 21

NAV will increase if:

• The value of the securities in the portfolio increases
• The portfolio receives investment income, such as interest payments from bonds

NAV will decrease if:

• The value of the securities in the portfolio falls
• The fun distribute dividends or capital gains

NAV will not change if:

• Investor purchases and redemptions
• Portfolio purchases and sales of securities
• Sales charges

Question 22

12B-1 fees

Answer 22

To start and continue a 12B-1 fee, three votes must initially approve the fee annually re-approve it. The three votes are:

• A majority vote of the board of directors
• A majority vote of the non-interested board of directors
• A majority vote of the outstanding shares

To terminate, only 2 votes are required:

• How majority vote of the non-interested board of directors
• How majority vote of the outstanding shares

All fees are reviewed quarterly.

Question 23

Sales charge % calculation

Answer 23

(POP - NAV)
SC% = ——————
POP

Question 24

POP calculation

Answer 24

NAV
POP = ——————-
(100% - SC%)

Question 25

Breakpoint Sales

Answer 25

A breakpoint sale is a violation committed by a registered representative who is trying to earn a larger commission by recommending the purchase of mutual fund shares in a dollar amount that is just below the breakpoint, which would allow the investor to qualify for a reduced sales charge.

A breakpoint violation may also be considered to have been committed if a representative spreads out a large sum of money over different families of fonts.

Combination privileges allow an investor to combine the simultaneous purchase of two different portfolios to reach a breakpoint sales charge reduction.

Question 26

Mutual Fund current yield calculation

Answer 26

Annual income / POP = current yield

The higher the yield, the more income the phone produces for every dollar invested.

Question 27

DCA: Average cost vs average price

Answer 27

total dollars invested
Average Cost = ————————————-
total # of shares invested

total of share prices
Average Price = ———————————–
number of purchases

Question 28

Real Estate Investment Trust (REIT)

Answer 28

Organize for the specific purpose of buying, developing, or managing a portfolio of real estate.

A REIT will not pay taxes at the corporate level as long as:

• It receives 75% of its income from real estate
• It distributes at least 90% of its taxable income to shareholders
• At least 95% of its income is derived from real estate activities