Chapters 9/10 Flashcards

Question

True or false: A mutual fund is not required to disclose all of its fees?

Answer 1

False, a mutual fund MUST disclose all of its fees at the front of its propsectus.

Answer 2

The % of fund assets used to pay operating costs The % of fund assets ÷ avg. net assets | Measures a mutual fund's operating efficiency

Answer 3

Usually have front-end loans but small or no 12b-1 fees. Investors who purchase large amounts of shares within the same fund family may be given reduced sales charges. This class of mutual fund shares is most suited for LT investors. ## Footnote * The disadvantage to Class-A shares is that not all of the initial investment gets invested. Ex: If there's a 1% front-end load, and an investor invests $100, then only $99 gets invested.

Answer 4

No front-load charges but higher 12b-1 fees. Investors are also subject to back-end loads. This class of shares is most suitable for investors who have a 5-7 year timeframe, especially if the back-end load decreases over time. ## Footnote * W/ Class B shares, once enough time has passed to where there is no back-end load, most Class B shares will convert to Class A.

Answer 5

Shares that have a *level load* , which is an ongoing fee (typically 1%) for as long as the investor holds the shares. There's no front-end or back-end load, but a back-end load may be applied if the shares are sold within a year. This class has higher 12b-1 fees than Class A. This class of shares is most suitable for ST investors.

Answer 6

$ levels at which the sales charge is reduced. Mutual fund shares MUST be quoted at the maximum sales charge, but most mutual funds offer breakpoints on shares purchased w/ a front-end load. Ex: W/ $100k of purchases, sales charge reduced from 1% to 0.5%. | The breakpoint is set by the fund, NOT anyone selling it. ## Footnote * Breakpoints must be clearly stated in the prospectus.

Answer 7

* If the variations apply to all investors * Adequate info is given to shareholders and potential investors * The prospectus is revised if variation schedules are changed * The company advises its existing shareholders of any new variations within a year.

Answer 8

Allows an investor to qualify for a breakpoint w/o initially depositing the entire amount required. Since an LOI is nonbinding, if the investor fails to make the additional payment to meet the required amount, they will not be penalized but they will be charged an amount that equals the higher sales charge applied to the purchase. ## Footnote * A letter of intent (LOI) allows an investor to reach a breakpoint without initially investing the entire amount and it covers a period of 13 months. The letter may be backdated 90 days.

Answer 9

Rights that allow a mutual fund shareholder to receive reduced sales commission charges when the amount of mutual funds purchased plus the amount already held equals the ROA breakpoint.

Answer 10

* An individual * A buyer's immediate family member * A fiduciary * A trustee * Certain pension and profit-sharing plans * Other groups that were not formed solely for the purpose of paying reduced sales charges. | Only purchasers of Class A shares are eligable for breakpoints.

Answer 11

False, dividends that are reinvested from a mutual fund are reinvested at NAV and are taxable and add to the client's cost basis.

Answer 12

When investors reinvest dividends at fixed $ amounts of regular intervals, regardless of the market price of the shares. This leads to the investor buying more shares when the price is low and less shares when the price is high.

Answer 13

* No assurance of LT growth * Prices will vary * Contributions must continue when prices decline, otherwise losses could occur.

Answer 14

False, SEVEN CALENDAR days

Answer 15

When investors receive regular payments from their accounts, typically on a monthly or quarterly basis. Investors have 3 options: fixed $, fixed %, or fixed-time (liquidating their holdings over a period of time). Payments are first made from dividends and then on capital gains. However, if these are not sufficient then it will begin to redeem their shares. Systematic withdrawal plans from mutual funds do not work like annuities. A systematic withdrawal plan could eventually result in the exhaustion of the account, whereas a life annuity payout will continue as long as the annuitant lives.

Answer 16

Some mutual funds assess a small redemption fee of 0.5% to 2%. Some funds waive these fees if the shares have been held for a certain amount of time.

Answer 17

RRs are not allowed to induce clients to purchase shares at a level that's just below the value where a breapoint is available. Clients should be advised to use LOIs, if available.

Answer 18

RRs are prohibited from pressuring clients to immediately purchase mutual fund shares in order to capture an impending dividend. There's no economic benefit to the customer since once the dividend is paid, the fund's NAV will fall, and by receiving the dividend the customer will have to pay taxes on them.

Answer 19

RRs are prohibited from advising clients to sell existing mutual fund shares and buy into another fund within the same family so that a new sales charge will be levied. This CAN be done if it's in the client's best interest but RRs cannot abuse this just to make money.

Answer 20

False, Class B shares do NOT get a breakpoint.

Answer 21

An investment company that passes through at least 90% of its net investment income (dividends plus interest minus expenses) to shareholders. RICs benefit from tax benefits.

Answer 22

Investor A makes an initial investment of $20k into a mutual fund and acquires 702 shares. Over the next 5 years, investor A deposits another $25k and reinvests $14k and acquires another 1,240 shares. Total $ amount deposited: ($20k + $25k + $14k) = $59k Total amount of shares acquired= (702 + 1,240) = 1,942 Average cost basis = ($59k ÷ 1,942) = $30.38

Answer 23

* Receiving dividends * Reinvesting dividends * Exchanging shares (within a fund family) * Switching shares (outside a fund family) | Any dividend is taxed as ordinary income. ## Footnote * Dividends can be qualified or non-qualified. For a dividend to be qualified, the mutual fund fund must have held the shares on which the dividend is paid for more than 60 days and the investor must have held the shares for more than 60 days.

Answer 24

Another type of open-end fund. A very rare type of investment company that issues debt certificates that pay a pretermined rate of interest. Investors can purchase these shares by making periodic payments or a lump sum and then receive a fixed amount if they hold these certificates until maturity. Investors who cash in these securities will receive a lesser amount- *the surrender value.*

Answer 25

Invest in a fixed portfolio of income-producing securities (bonds or preferred stock). UITs are formed under a legal document called an indenture. UITs issue units (a.k.a. *shares of beneficial interest (SBI)*). Each SBI entitles the holder to a proportionate amount of the UITs portfolio that the investor invested. Since the portfolio remains static, there is no fund manager and thus no mgmt. fees. UITs are supervised, not managed.

Answer 26

Unlike mutual funds that continuously issue shares, closed-end funds issue shares like a company- on a one-time basis. Similar to a corporation, secondary offerings can be issued later. Closed-end funds trade in secondary markets and they're traded on exchanges. There's no prospectus delivery requirement for these secondary market trades. The price of closed-end funds is determined by market forces, not NAV, and when closed-end fund shares are bought or sold the investors are subject to commissions rather than sales charges. | Closed-end funds may be sold short and bought on margin, unlike open-end ## Footnote * Closed-end funds can issue common stock or senior securities- pref. stock/ bonds

Answer 27

The most common type of closed-end fund. ETFs issue shares which track an underlying index. An ETF may be appropriate for customers who are investing a lump-sum and seeking diversification and low costs. ETFs also may be suitable for investors looking to implement an asset allocation plan. ETF portfolios are generally fixed.

Answer 28

Attempts to perform the opposite of the index it's tracking. Essentially, the goal is to yield performance equal to shorting the index. ## Footnote * When selling short, an investor is exposed to a potential unlimited loss; however, with an inverse ETF, the investor is only exposed to a potential loss of the instrument’s purchase price (i.e., ETFs offer limited liability).

Answer 29

Leveraged ETFs are products that use debt instruments or financial derivatives such as swaps, futures, and options to amplify the returns of a specific index. For example, a leveraged ETF may be designed to deliver 2x the performance as the Nasdaq. ## Footnote * Since most leveraged ETFs reset their portfolios and leverage daily, investors should typically sell their holdings before the market closes at the end of the day. For example, if an investor invests $1k into a 2x leveraged ETF, and on day 1 the index rises 20%, the investor's ETF shares increase by 40% to ($1k * 1.40)= $1.4k. But, if on the second day the index falls by 20%, the investor's shares are now only worth ($1.4k * (1-0.4)) = $840. * The same logic as the bullet above applies to inverese ETFs as well.

Answer 30

False, leveraged ETFs and inverse ETFs are best used for short-term trading strategies such as attempting to take advantage of intraday price swings on a given index.

Answer 31

A contract between an owner and an insurance company where the owner gives the other party an amount of money and the insurance party agrees to pay the owner income at a later date. Annuities are inherently LT investments. Annuities grows tax-deferred. Annuities have a long-life and if the owner wants their money back there is a signficant surrender value. The majority of annuities are non-qualified, so the owner must invest on an after-tax basis. However, the money grows tax-deferred. If the owner withdraws from the annuity account before 59 and 1/2, there is a penalty on top of it being taxed. If the withdrawal is subject to taxation, it's taxed as ordinary income.

Answer 32

An annuity where the money being contributed is invested by the insurance company in its *general account*. W/ fixed annuities, the insurance company assumes the investment risk, and for this reason these are NOT considered securities. W/ fixed annuities, the insurance company will guarantee a min. rate of return or a fixed $ amount to be provided (the insurance company has to pay regardless of the general account's performance). Fixed annuities are good for conservative investors seeking tax-deferred growth. RRs MUST disclose that these are LT investments. The disadvantage to fixed annuities is that the fixed $ amount will not keep pace w/ inflation and the fixed rate of return might not. ## Footnote * The assets from the fixed annuity in the general account are mixed w/ the assets from other insurance plans (life insurance, health insurance, etc.)

Answer 33

Rather than choosing from a fixed rate of return or a fixed $ amount, investors choose from several options (growth, income, LT bonds, aggressive growth, etc.). Contributions are invested in the insurance company's *separate account*. Nothing about a variable annuity is guarenteed. The assets in the separate account are not mixed w/ assets from the general account. The separate account must be registered w/ the SEC. Variable annuities provide investors w/ variable payments at regular intervals for the contract term. All the risk is assumed by the annuitant, NOT the insurance company. Variable annuities can provide a hedge against inflation. A prospectus MUST be delivered to prospective annuitants. These types of annuities are generally NOT suitable for senior investors, but moreso for people w/ LT investment goals who will not need access to their money for at least 5-7 years. ## Footnote * Investors may choose to transfer assets from one subaccount within the separate account (ex: aggressive growth to income) w/o incurring taxes or sales charges.

Answer 34

Immediate annuities = When payments to the annuitant begin immediately after the lump sum is paid. If the contract is for monthly payments, payments will begin one month after the lump sum is paid. If annual payments, one year after the lump sum is paid. Deferred annuities= When payments to the annuitant are delayed for a period of time after the lump sum is paid. In these cases, sometimes the lump sum is paid as a series of payments rather than a single premium. ## Footnote * For Series 7 Examination purposes, if not specified, it should be assumed that the questions are referring to non-qualified deferred contracts which are funded with after-tax dollars.

Answer 35

1. The accumulation period 2. The annuity period

Answer 36

When the owner/annuitant makes payments to the insurance company and the value of the annuity begins to grow. While mutual fund investors buy shares, variable annuity investors buy accumulation units. Investors buy accumulation units at NAV and are normally assessed a deferred sales charge. The NAV of every subaccount is calculated daily. Annuities use the same forward pricing method as mutual funds. If the annuitant dies during the accumulation period, a designated beneficiary will receive the greater of the sum of total payments made or the value of the accumulation units owned.

Answer 37

* Sales charges: Most of the time in the form of a contingent deferred sales charge that's assessed if the annuity isn't held for a certain period of time (similar to Class B shares of a mutual fund). * Mgmt. fee * Expense risk charges: When a firm issues a variable annuity, it guarentees it will not raise costs for administering the contract beyond a certain level. This expense compensates the firm if the costs to the firm for adminstering the annuity turn out to be more than estimated. * Admin. expenses * Mortality risk: The risk that the individual lives for a very long time and the firm has to make payments for the entirety of it.

Answer 38

When the annuitant begins to receive payments. During this period, accumulation units are converted into a FIXED # of annuity units. The number of annuity units on which each payment is based is fixed, but the value will fluctuate.

Answer 39

* Age and gender * Life expectancy * Selected payout option * Projected growth rate (a.k.a. the assumed interest rate (AIR))

Answer 40

* Straight-life annuity * Life annuity w/ period certain * Unit refund life annuity * Joint and last survivor life annuity

Answer 41

A payout option where the annuitant will get a payment at a certain interval (monthly, yearly, etc.) for the rest of their life but after they die it's over- their is no beneficiary. So even if only one payment is made and then they die, it's over. | This payout option provides the highest possible payout of all options

Answer 42

A payout option where periodic payments are made for a certain period of time, but if the annuitant dies prior to the end of that period, a lump sum or series of payments is made from the insurance company to a beneficiary.

Answer 43

A payout option where periodic payments are made during the annuitant's lifetime, and if the annuitant dies before an equal value to the amount they put in is paid out, the remainder is paid to a beneficiary w/ either a lump sum or series of payments from the insurance company.

Answer 44

A payout options where payments are made to 2 or more people. If one person dies, the survivor continues to receive only his/her payments. Once the death of the last person, payments cease.

Answer 45

Once the payout option is selected, an AIR is selected to determine the first annuity payment. This is a projected return rate. Going forward, the AIR becomes the benchmark for determining subsequent payments. Annuitants can choose from various assumed interest rates when annuitizing their contracts. If the actual separate account return rate DOESN'T exceed the AIR, the annuity payment decreases. ## Footnote * Each state has a maximum AIR. * If the separate account performance is equal to the AIR, the annuitant's payment will remain the same as the previous payment.

Answer 46

Annuities can be qualified or non-qualified. Only certain investors are eligable for qualified status. Non-qualified investors use after-tax money to contribute, and then the money grows tax-deferred. Any money withdrawn is not taxed, only the earnings. If an investor makes withdrawals during the accumulation period, earnings are taxed on a LIFO basis. For example, if an investor has made contributions of $50k to a non-qualified variable annuity and the account currently has a $150k value, and the investor withdrawals $110k, the first $100k would be taxed as ordinary income becuase it was earned through dividends and capital gains. The next $10k is tax-free. The investor CANNOT claim $50k is tax-free.

Answer 47

For a non-qualified annuity, at each periodic payment, the annuitant is only taxed on investment income (the part of the payment that represents dividends and capital gains). The annuitant is NOT taxed on the money they contirbuted. For a qualified annuity, since the contributions were pre-tax, the entire periodic payment during the annuity period is taxable as ordinary income.

Answer 48

If an annuitant dies during the accumulation period, the annuity's value is included in their estate for the purpose of calculating federal estate taxes. The beneficiary will also be required to pay ordinary income taxes on anything they receive in excess of the cost basis. The death benefit skips the probate process. | Probate is how a dead person's will is validated.

Answer 49

Anyone selling a variable annuity must hold a Series 6 or Series 7 license. Separate accounts for variable annuities must be registered as investment companies. FINRA member firms selling these policies must promptly transmit all applications and premiums for variable products to the insurance companies. RRs must obtain principal approval to sell a variable annuity. The principal can take up to 7 business days from the time they receive the application to decide if it's suitable for the customer. The BD must keep a record of any payment from the customer and the date of payment, as well the date the BD forwards the funds to the insurance company. ## Footnote * FINRA members that are principal underwriters of variable products may not sell them through another BD unless the other BD is also a FINRA member. * As is the case w/ mutual funds, any selling agreement between an underwriter and a BD must state that if a client cancels the contract within 7 business days after the application is accepted, the BD will return the sales commission to the insurance company that issued the contract. * A FINRA member firm is prohibited from selling variable contracts that are issued by an insurance company that doesn’t promptly pay clients who surrender (cash in) all or part of their contracts

Answer 50

1. The customer understands the various features of the contract (surrender periods and charges, fees, etc.) 2. The customer will benefit from some features 3. The contract has subaccount choices and features that make it suitable

Answer 51

A tax-free exchange of a variable product to another similar fund. RRs must take into account that clients might inccur surrender charges or other fees, and must keep the client's best interest in mind. ## Footnote * An exchange is often viewed as inappropriate if the client has made another 1035 deferred variable annuity transfer within the previous 36 months. * Clients should not be recommended the purchase of variable annuities within a tax-deferred account (ex: IRA) because those accounts already grow tax-deferred.

Answer 52

Variable annuities that have deferred sales charges that decline to 0 in 3-4 years and are designed for customers who may be considering a 1035 exchange in the future.

Answer 53

A form of permanent insurance which require fixed premiums, but have death benefits and cash values that may vary based on performance of the investment options. Anything w/ the term variable is considered a security, and thus variable life insurance policies are securities. Any offers to sell life insurance policies must have a prospectus attached. Only a life insurance company that's licensed and regulated by the state may ISSUE a variable policy. The company that SELLS the policy must be a BD registered w/ the SEC and a FINRA member firm. The RR must have a Series 6 or 7 license. W/ variable life insurance, the policy owner decided how the premium payments will be invested. A feature of these policies is that there is a guarenteed minimum death benefit. Variable life insurance policies are not suitable for super conservative investors because the policy's value may vary. ## Footnote * The death benefits, which vary with the performance of the separate account, are calculated annually. If an investor chooses to take a loan against the accumulated value, interest is charged.

Answer 54

Policyholders make premium payments to the insurance companies, and those proceeds are deposited into the separate account net of any sales charges or fees. Policyholders choose their desired subaccount. Policyholders accumulate cash value where they can borrow (to pay premiums) later in life. They may also pass this down to heirs. Policyholders can use the cash value as a tax-sheltered investment. The death benefit on a life insurance policy has a guarenteed minimum but may rise above this min. if the subaccounts perform well. ## Footnote * Owners of variable life insurance policies get voting rights on certain issues with subaccount decisions. * Each subaccount has a Board of Managers (essentially a BOD).

Answer 55

An additional feature/benefit addded to a life insurance policy. Each rider adds to the cost of the policy. Riders are often selected at the time of policy issuance but can be added later on as well.

Answer 56

The death benefit of a life insurance policy passes tax-free to the beneficiary, however, if the dead person owned the policy, the death benefit is included in the calculation of estate taxes. In order to avoid this, many advisors recommend the policy be placed in the name of a beneficiary or irrevocable life insurance trust.

Answer 57

Hybrid products that contain aspects of fixed and variable annuities. These are NOT securities. The return on an EIA is linked to an underlying stock index performance. In order for there to be some guarenteed minimum payout, investors must accept the equity-indexed annuities return will be less than the underlying index.

Answer 58

What's used to calculate an equity-indexed annuity's return. Example, a participation rate of 80% suggests that if a equity-indexed annuity is tied to the S&P which rises 10%, then the annuity will return 8%. Another way to determine returns for an equity-indexed annuity is to use a spread. For example, an equity-indexed anuity uses a 3% fixed spread to calculate returns, if the S&P rises 10%, the return will be 7%.

Answer 59

Some equity-indexed annuities have rate of returns that are capped at some set %.

Answer 60

1. Annual reset (Ratchet): Calculates the contract's return based on the amount the underlying index has increased of BOY to EOY. The advantage to this is the gains are locked in every year and decreases ignored. 2. High-Water Mark: Issues the 3 highest values of the index at points during the life of the contract to calculate the rate of return. May provide higher returns than #1. 3. Point-to-Point: Compares the index's value on the date the contract began and the date it ended. The advantage w/ this is it may be combined w/ higher caps or participation rates. The disadvantage is the returns are based on very specific dates. 4. Index Averaging: Rather than using the index's value on specific dates, uses average values on a daily or monthly basis.

Answer 61

Not suitable for older investors who need income. Not good for ST investors.

Answer 62

True ## Footnote * The IA is given authority over distributions.

Answer 63

False, both fixed and variable annuities have higher sales charges and ongoing fees than mutual funds.

Answer 64

Suitability requirements for recommendations concerning the purchase of variable annuities apply to the following three scenarios: 1. New purchases 2. Exchanges of variable annuities 3. Initial subaccount allocations.

Answer 65

Investors placing orders after the close of the market (based on information that they have learned after the close), and seeking to purchase shares at prices determined before the close, are engaging in late trading, which clearly places other investors in that mutual fund at a clear disadvantage. The investor must receive the price as calculated by the fund company at the NAV on the following day.

Chapters 9/10 Flashcards

(95 cards)