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Unit 10: Investment Company Products

Investment Company
-pools investors’ money and invests in securities on their behalf
-management attempts to invest funds for people more effeciently than the individual investors could themselves
-operate and invest these pooled funds as a single large account jointly owned by every investor in the company
-raise capital by selling shares to the public
-*must abide by registration and prospectus requirements of Act of 1933-*
-*SEC regulation by the Investment Company Act of 1940 -*
The Investment Company Act of 1940
-classifies investment companies into three broad types:
>Face Amount Certificate Companies (FACs)
>Unit Investment Trusts (UITs)
>Management Invesment Companies
Face Amount Certificate
-a contract between an investor and an issuer in which the issuer guarantees payment of a stated (or fixed) sum to the investor at some set date in the future
-in return for this future payment, the investor agrees to pay the issuer a set amount of money either as a lump sum or in periodic installments
Face Amount Certificate Companies (FACs)
-issuers of these investments
-few exist because tax law changes have eliminated their tax advantages
-if the investor pays for the certificate in a lump sum, the investment is known as a fully paid face-amount certificate
Unit Investment Trusts (UITs)
-an investment company organized under a trust indenture and identified by several characteristics
-do NOT have board of directors, employ investment advisors, or actively manage their own portfolios
-functions as a holding company for its investors
-typically purchase other investment company shares or government and municipal bonds
-issue redeemable shares, aka units or shares of beneficial interest; each share is an undivided interest in the entire underlying portfolio
-proceeds are distributed pro rata (proportionate) to unit holders
-may be fixed or nonfixed
>*Fixed: purchases a portfolio of bonds and terminates when the bonds in the portfolio mature
>Nonfixed: purchases shares of an underlying mutual fund*

The major difference is that mutual funds actively trade their portfolios; a portfolio manager gets paid a fee to buy and sell as needed to meet the objectives of the fund.
> UITs are *not actively managed; there is no BOD or investment adviser.*
> UIT portfolios usually are *not traded; they are fixed trusts. *
> The advantage to investors in UITs is that they own a diversified interest, but they do not have to pay a management fee—the biggest expense of mutual fund ownership.*
> The downside is UIT shares (units) are not traded in the secondary market; they must be redeemed by the trust.
> UITs are investment companies as defined under the Investment Company Act of 1940.

Management Investment Companies
-actively manages a securities portfolio to achieve a stated investment objective
-can either be closed end or open end
Closed-End Investment Companies
-conducts a common stock offering to raise capital for its portfolio
>fixed; single offering of shares
>common and preferred stock, debt securities
>Full only
Offerings and Trading
>Initial primary offering
>Secondary trading OTC or on an exchange
>Does not redeem Shares
>CMV + commission
>Price determined by supply and demand
Shareholder Rights
>Dividends (when declared), voting, preemptive
-*>Set by exchange or FINRA-*

Referred to as publicly traded funds or exchange-traded funds (EFTs)

Closed-end Fund Features
? Where do shares of closed-end companies trade? Like corporates, in Secondary Market
? What types of securities can closed-ends issue? Like corporates, common, preferreds, bonds
? Can fractional shares be purchased? Like corporates, only full shares
? When must a prospectus be used? Like corporates, only in the IPO.
No prospectus is given when shares are purchased in secondary market
Close End Fund Advantages
? Pricing and ease of trading—ETFs are traded on exchanges
? Margin—ETFs can be bought and sold on margin. Mutual funds cannot
? Operating costs—ETFs have operating costs and expenses lower than mutual funds.
? Tax efficiency—ETFs do not distribute capital gains annually like mutual funds. There are no tax consequences with ETFs until investors sell shares.

Peter and Mary Own Toyota

Close End Fund Disadvantages
? Commissions – ETFs is a commissionable transaction. Will erode the low cost
? Over Trading—Can drive up costs
Open-end Investment Companies
>unlimited; continuous offering of shares
>common stock only; no debt securities; permitted to borrow
>Full or fractional
Offerings and trading
>Sold and redeemed by fund only
>Continuous primary offering
>Must redeem shares
>NAV + sales charge
>Selling price determined by formula in prospectus
Shareholder Rights
>Dividends (when declared), voting
>Set by BOD
-*have no more than one class of security issued and a minimum asset-to-debt ratio 300%-*
-under the Investment Company Act of 1940, an invesment company qualifies as a diversified investment company if it meets the following 75-5-10 test
75-5-10 Test
-*75% of total assets must be invested in securities issued by companies other than the investment company or its affiliates
-75% must be invested in such a way that:
>within the 75%, no more than 5% of the fund’s total assets are invested in the securities of any one issuer
>within the 75%, the fund does not own more than 10% of the outstanding voting securities of any one issuer -*
– a fund could have as much as 30% of its assets invested in one company (25 + 5) and own more than 10% of a company and still call itself diversified
-a nondiversified investment company fails to meet the 75-5-10 test
-a company that specializes in a single industry is not necessarily a nondiversified company
Specialized/Sector Funds
-investment company that chooses to concentrate their assets in an industry or a geographic area, such as healthcare, technology stocks, or northeast coast company stocks
Comparison of Open-End and Closed-End Investment Companies
OPEN ENDED (Mutual Funds)
1. Capitalization = Unlimited; a continuous offering of shares
2. Issues = Common stock only; no debt; allowed to borrow
3. Shares = Full or fractional
4. Offerings and Trading = Sold and redeemed by fund only; Continuous primary offering. Must redeem shares
5. Pricing = NAV + sales charge; price determined by formula in prospectus
6. Shareholder Rights = Dividends (when declared), voting
7. Ex-date = Set by BOD

1. Capitalization = Fixed; single offering of shares
2. Issues = Common; preferred stock, debt securities
3. Shares = Full only
4. Offerings and Trading = Initial primary offering; Secondary trading is OTC or on an exchange; Does not redeem shares
5. Pricing = CMV + commission; Price determined by supply and demand
6. Shareholder Rights = Dividends (when declared), voting, preemptive
7. Ex-date = Set by Exchange or FINRA

Common Stock versus M/F Shares
A. Dividends from corporate profits
B. Price of stock determined by supply and demand
C. Traded on an exchange or the OTC market
D. Sold in full shares only
E. First security issued by a public corporation
F. Carries voting rights
G. May carry preemptive rights
H. Ex-dividend: two business days

A. Dividends from net investment income
B. Price of share determined by forward pricing—the next NAV per share calculated as determined by the fund’s pricing policy
C. Purchased from and redeemed by the investment company; no secondary trading
D. Can purchase full or fractional shares
E. Only security issued by a mutual fund
F. Carries voting rights
G. DOES NOT carry preemptive rights
H. Ex-dividend: typically the day after record date as set by the BOD

Investment Company Registration
-Must register with the SEC as an investment company if it:
>is in the business of investing in, reinvesting in, owning, holding, or trading securities
-*>has 40% or more of its assets invested in securities (government securities and securities of majority-owned subsidiaries are not used in calculating the 40% limitation)-*
-investment company may not issue securities to the public unless it has:
-*>private capitalization (seed money) of at least $100,000 of net assets
>100 investors-*
>clearly defined investment objectives
-*can register a public offering with the SEC if it can meet these requirements within 90 days of registration*
40%: 100,000, 100, Ob, 90
Investment Objective
-must be clearly defined under, which it plans to operate
-once defined, the objective may be changed only by a majority vote of the company’s outstanding shares
SEC Registration and Public Offering Requirements
-an investment company must identify:
>the type of investment company it intends to be (ie open-end or closed-end)
>plans the company has to raise money by borrowing
>the company’s intention, if any, to concentrate its investments in a single industry
>plans for investing in real estate or commodities
>conditions under which investment policies may be changed by a vote of shares
>the full name and address of each affiliated person
>a description of the business experience of each officer and director during the preceding five years

*type : plans (raise, invest, concentrate) : affiliated personnel (experience of directors dating by to 5 yrs)*

Registration Statement
-Part 1
>the prospectus that must be furnished to every person to whom the company offers the securities
>called an -*N1-A prospectus or a summary prospectus *
– must contain the SEC disclosure
-Part 2
>the document containing information that need not be furnished to every purchaser but must be made available for public inspection
>called the *statement of additional information *
Summary Section
-SEC mandates that mutual fund disclose in their prospectuse:
>Investment objectives
>Costs of investing
>Principal investment strategies, risks, and performance
>Investment advisors and portfolio managers
>Brief purchase, sale, and tax information
>*Financial intermediary compensation*

> Objectives / costs
Strategies/ Risks/ Performance
Advisors/ IC compensation
Portfolio information

Statement of Additional Information (SAI)
-mutual funds and closed-end funds are required to have a SAI available to investors upon request without charge
-can obtain thru writing, calling the investment company, via company website, contacting a broker of the shares, or the SEC
-affords the fund an opportunity to have expanded discussions on such matters as the fund’s history and policies
-typically contains the fund’s consolidated financial statements
Continuous Public Offering Securities
-SEC treats the sale of *open-end investment company shares* as a continuous offering of shares, which means *all sales must be accompanied by a prospectus*
-*financial information must be dated not more than 16 months before the sale*
-closed-end only the initial public offering of stock is sold with prospectus
-*mutual funds shares may be used as collateral in a margin account if they have been held fully paid for more than 30 days’*
-*cannot purchase mutual fund shares on margin
Restrictions on Operations
-the fund must disclose the following activities and the extent to which it plans to engage in these activities in its prospectus:
>purchasing securities on margin
>selling securities short
>participating in joint investment or trading accounts or acting as distributor of its own securities, except through an underwriter
margin/ short/Joint account / Distributor
Shareholder’s Right to Vote
-*one shareholder holding 51% of all the shares outstanding can determine a vote’s outcome*
-Changes requiring a majority vote:
>changes in borrowing by open-end companies
>issuing or underwriting other securities
>purchasing or underwriting real estate
>making loans
>changing subclassification (ie from open-end to closed-end or from diversified to non diversified)
>changing sales load policy (ie from a no-load fund to a load fund)
>changing the nature of business (ie ceasing business as an investment company)
>changing investment policy (ie from income to growth or from bonds to small capitalization stocks)
Investment Co Operations
.A. Handles Admin Duties
.B. Elected by SH
.A. Makes Investment decisions
.B. Paid a % of Assets
.A. Holds Assets
.B. Paid a Fee by Fund
.C. Clerical Duties
.A. Issues and Redeems Shares
.B. Paid a Fee By the Fund
.A. Distributes Shares
.B. Paid from Sales Charges
Board of Directors
-serves the interest of its investors
-concern themselves with *policy and administrative matters*
-elected by shareholders
>defines the *type* of fund(s) to offer (ie growth, income, or sector)
>defines the fund’s *objective*
>approves and hires the transfer agent, custodian, and investment adviser
* must serve a minimum of 1 year – but cannot serve more than 5 years without being reelected*
-Act of 1940 restricts who may sit on an investment company’s board of directors
-persons connected with the investment company only in their capacity of directors
Investment Adviser
-an investment company’s BOD contracts with an outside investment adviser or PM to:
>invest the cash and securities in the fund’s portfolio
>implement investment strategy
>identify the tax status of distributions made to shareholders
>manage the portfolio’s day-to-day trading
-contract is for a *maximum of 2 years,* but is subject to annual shareholder approval
-earns a management fee, *paid from the fund’s net assets*
-if he outperforms, elilgible for an incentive bonus
-Act of 1940 requires each investment company to place its portfolio securities in the custody of a bank or a stock exchange member B/D
-handles most of the investment company’s clerical functions
-hold’s assets
-paid a fee by the fund
– keep the investment company’s assets physically segregated at all times; and
– restricts access to the account to certain officers and employees of the investment company.
Transfer Agent
-Functions include: (DOES NOT SELL)
>issuing, redeeming, and canceling fund shares
>handling name changes for the fund
>sending customer confirmations and fund distributions
>recording outstanding shares so distributions are properly made
Underwriter (Sponsor/Distributor)
-appointed by the BOD and receives a fee for selling and marketing the fund shares to the public
-open-end company sells its shares to the underwriter at the current NAV
-*a fund is allowed to act as its own underwriter under Section 12b-1 of Act of 1940*
-distribute shares
-paid from sales charges
– commonly *referred as the sponsor or distributor*
-must be distributed to an investor *before or during any solicitation for sale*
-contains information on the fund’s objective, investment policies, sales charges, management expenses, services offered, and *discloses 1-, 5-, 10-year performance histories*

-the SAI includes:
>balance sheet
>statement of operations
>income statement
>portfolio list at the time the statement was compiled

Financial Reports
-must receive *semiannually*
-*audited report annually*
-must contain:
>the investment company’s balance sheet
>a valuation of all securities in the investment company’s portfolio as of the date of the balance sheet (a portfolio list)
>the investment company’s income statement
>a complete statement of all compensation paid to the BOD and to the advisory board
>a statement of the total dollar amount of securities purchased and sold during the period
Additional Disclosures
-MFs must include in prospectus or annual report the following:
>a discussion of those factors and strategies that materially affected its performance during its most recently completed fiscal year
>a line graph comparing its performance to that of an appropriate broad-based securities market index
>the name(s) and title(s) of the person(s) primarily responsible for the fund portfolio’s day-to-day management
Characteristics of Mutual Funds/Concept
-a professional investment adviser manages the portfolio for investors
-mutual funds provide diversification by investing in many different companies
-a custodian holds a mutual fund’s shares to ensure safekeeping
-*most funds allow a minimum investment, often $500 or less, to open an account, and they allow additional investment for as little as $25*
-an investment company may allow investments at reduced sales charges by offering breakpoints- for example, through larger deposits, a letter of intent, or rights of accumulation
-an investor retains voting rights similar to those extended to common stockholders, such as the right to vote for changes in the board of directors, approval of the investment adviser, changes in the fund’s investment objective, changes in sales charges, and liquidation of the fund
-many funds offer automatic reinvestment of capital gains and dividend distributions without a sales charge
-an investor may liquidate a portion of his holdings without disturbing the portfolio’s balance or diversification
-tax liabilities for an investor are simplified because *each year the fund distributes a 1099 form explaining taxability of distributions*
-a fund may offer various withdrawal plans that allow different payment methods at redemption
-funds may *offer reinstatement provisions that allow investors that withdraw funds to reinvest up to the amount withdrawn within 30 days with no new sales charge*. This provision must be disclosed in the prospectus and is available one time only
Common Stock
-normally the growth component of any mutual fund that has growth as a primary or secondary objective
-*bonds, preferred stock, and blue-chip stocks are typically used to provide the income component of any mutual fund that has income as a primary or secondary objective

Growth Funds
Income Funds
Combination (Income + Growth)
Specialization / Sector funds
Special Situation Funds
Index Funds
Foreign Funds

Balance (Stocks + Bonds)
Asset Allocation (Stock + Bonds + Money Market)

Growth Funds
-invest in stocks of companies whose businesses are growing rapidly
-tend to reinvest all or most of their profits for research and development rather than pay dividends
-growth funds are focused on generating capital gains rather than income
Income Funds
-stresses current income over growth
-invest in the stocks of companies with long histories of dividend payments, such as utility company stocks, blue-chip stocks, and preferred stocks
Combination Funds/Growth and Income Funds
-may attempt to combine the objectives of growth and current yield by diversifying its portfolio among companies showing long-term growth potential and companies paying high dividends
Specialized/Sector Funds
-specialize in particular economic sectors or industries *(Investment 25%…..)*
-include gold funds, technology funds, low-grade (non-investment grade) bond funds
-offer high appreciation potential but may also pose higher risks to the investor
Special Situation Funds
-buy securities of companies that may benefit from a change within the companies or in the economy
-ie takeover candidates, companies with patents pending, and turnaround situations
Index Funds
-invest in securities to mirror a market index, such as the S&P 500
-buys and sells securities in a manner that mirrors the composition of the selected index
-the fund’s performance tracks the underlying index’s performance
-has lower management costs than other types of funds due to the minimal turnover rate
Foreign Stock Funds
-invest mostly in the securities of companies that have their principal business activities outside the US
-long-term capital appreciation is their primary objective, but some seek current income
Balanced Funds
-invest in stocks for appreciation and bonds for income
-different types of securities are purchased according to a formula that the manager may adjust to reflect market conditions
-may contain 60% stocks and 40% bonds
Asset Allocation Funds
-split investments between stocks for growth, bonds for income, and money market instruments or cash for stability
-fund advisers switch the percentage of holdings in each asset category according to the performance, or expected performance, of that group
-may have 60% in stocks, 20% in bonds, and 20% in cash
Bond Funds
-income as their main investment objective
-some invest solely in investment-grade corporate bonds
-others seeking safety invest in government issues only
Tax Free (or Exempt) Funds
Govt & Agency Security Funds

Hybrid with Stocks
Dual-Purpose (Int or div or capital gains)

Tax-Free (Tax-Exempt) Bond Funds
-invest in municipal bonds or notes that produce income exempt from federal income tax
-can invest in municipal bonds and tax-exempt money market instruments
US Government and Agency Security Funds
-purchase securities issued by the US Treasury or an agency of the US government (Ginnie Mae)
-investors seek current income and maximum safety
Dual-Purpose Funds
-closed-end funds that meet two objectives:
1. investors seeking income purchase income shares and receive all the interest and dividends the fund’s portfolio earns
1. investors interested in capital gains purchase the gains shares and receive all gains on portfolio holdings
Money Market Funds
-usually no-load, open-end mutual funds that serve as temporary holding tanks for investors who are most concerned with liquidity
-No Load: investors pay *no sales or liquidation fees*
-fund manager invest the fund’s capital in money market instruments that pay interest and have short maturities
-*interest rates are not fixed, guaranteed and change often*
-*interest* earned is *computed daily and credited to customer’s accounts monthly*
-*NAV is set at $1 per share*
-both purchased and redeemed at their NAV
-the price of MM shares does not fluctuate in response to changing market conditions

*IR – not fixed, commuted daily, credited monthly
NAV – Fixed at $1 – Price does not fluctuate
purchase and redeemed at NAV
not insured by US Govt*

Restrictions on Money Market Funds
-Restrictions include:
>the front cover of every prospectus must prominently disclose that an investment in a money market fund is neither insured nor guaranteed by the US government and that an investor has no assurance the fund will be able to maintain a stable NAV. Must appear in all literature used to market the fund
>*investments are limited to securities with remaining maturities of not more than 13 months, with the average portfolio maturity not exceeding 90 days*
>investments include T-bills, commercial paper, repurchase agreements, and banker’s acceptances
Comparing Mutual Funds
-portfolio turnover
-services offered
-must reflect full sales load with no discounts
-manager’s track record in keeping with the fund’s objectives as stated in the prospectus
-*sales loads, management fees, and operating expenses* reduce an investor’s returns because they diminish the amount of money invested in a fund

-Sales Loads: historically, *MF’s have charged front-end loads of up to 8.5% of the money invested*
-this percentage compensates the sales force
-many *low-load funds charge between 2-5%*
-may charge a back-end load when funds are withdrawn
-some funds charge ongoing fees under Section
– some charge a redemption fee of .5% (but the total sales load cannot exceed 8.5%)
12b-1: deduct annual fees to pay for marketing and distribution costs

Expense Ratio
-compares the management fees and operating expenses, including 12b-1 fees, with the fund’s net assets
-all mutual funds have expense ratios
= *fund’s expenses/ average net assets*
*For stocks – 1% to 1.5%*
*For bonds – 0.5 to 1%*
Portfolio Turnover Ratio
-the costs of buying and selling securities, including commissions or markups and markdowns
-reflect’s a funds holding period
>100% = 1 year
>25% = 4 years
-Annual Turnover Rate: it’s not uncommon for an aggressive growth fund to reflect an annual turnover rate of 100%, which means the fund replaces it portfolio annually
-if superior returns are achieved, its working, if not, investors are subject to undue costs
Services Offered
-include retirement account custodianship, investment plans, check-writing privileges, telephone transfers, conversion privileges, combination investment privileges, withdrawal plans
Fund to Underwriter to Dealer to Investor
-fund sells shares to underwriter at the current NAV
-underwriter sells the shares to the dealer at the NAV plus the underwriter’s *concession (POP – dealer’s discount)*
-dealer sells the shares to the investor at the full POP
Fund to Underwriter to Investor
-fund sells shares to underwriter at the current NAV
-underwriter adds the sales charge and sells the shares to investor at POP
Fund to Investor
-no-load fund; fund sells to investor with no sales charge
-MFs must* calculate NAV at least once per business day (after the market closes 4:00 pm)*
– *Fund’s NAV = Assets (cash+current values of securities) – liabilities*
-*NAV per share = Fund’s NAV/ Number of shares outstanding*
Forward Pricing
-price of *purchase or redemption for mutual fund shares* is determined *at the next NAV calculation after an order is entered*
Changes in NAV
Change daily as follows:
-NAV per share increases when portfolio securities increase in value or when the portfolio receives investment income
-NAV per share decreases when portfolio securities decrease in value or when portfolio income and gains are paid to shareholders
– *NAV per share does not change when shares are sold or redeemed or when portfolio securities are bought or sold*
Sales Charges
-can not assess sales charge in excess of 8.5% of the POP
Closed-End Funds
-do NOT have sales charges
-pay a brokerage commission or markup/down
Open-End Funds
-all sales commissions and expenses are paid from the sales charges collected
3 different methods to collect fees:
>Front-end loads: diff between POP and net NAV (included in POP)
>Back-end loads: contingent deferred sales loads (structured so that it drops to zero after an extended )
>12b-1 sales charge: asset based fee
(can have different norms depending on share class. Maximum allowed under any share class condition is 1% of a fund’s net assets)
-*recommended for long-term investing
Front-End Loads
-the charges included in a fund’s public offering price
-charges are added to the NAV at the time an investor buys shares
Back-End Loads
-(contingent deferred load) charged at the time an investor redeems mutual fund shares
-structured so that it drops to zero after an extended holding period (specified in prospectus) (8% 1st year, 7% 2nd year)
12b-1 Asset-Based Fees
-permits a MF to collect a fee for promoting, selling, or undertaking activity in connection with the distribution of its shares
>*12b-1 fees* can have different norms depending on share class. *Maximum allowed under any share class condition is 1% of a fund’s net assets*
>the fee must reflect the anticipated level of distribution services
Computing Sales Charge Percentage
*POP – NAV = sales charge ($ amount)
Sales charge ($ amount)/ POP = sales charge %
NAV/ 100% – sales charge % = POP*
Reductions in Sales Charges
-to qualify for the maximum 8 1/2% sales charge, the investment company must offer:
>breakpoints: a scale of declining sales charges based on the amount invested
>rights of accumulation
>automatic reinvestment of distributions
-the schedule of quantity purchase discounts a mutual fund offers
-qualification: person includes married couples, parents and their minor children, corporations, and other certain entities
-investment clubs or associations formed for the purpose of investing do NOT qualify for breakpoints
-Breakpoint Schedule:
>$1 to $9,999 = 8 1/2 %
>$10,000 to $24,999 = 6 1/2%
>$25,000 to $49,999 = 4%
>$50,000+ = 2%
-no industry standardized breakpoint schedule
-MF’s that offer breakpoints must disclose their breakpoint schedule in the prospectus and how an account is valued for breakpoint purposes
-purchases made by the same investor in various accounts may be aggregated to qualify for a breakpoint discount
-*shares purchased in the same fund family, other than money market accounts, are eligible to be aggregated together to qualify for a breakpoint discount*
-a large, lump-sum investment is one method to qualify for a breakpoint
Letter of Intent
-*the investor informs the investment company of the intention to invest the additional funds necessary to reach the breakpoint within 13 months*
-the customer must complete the investment to qualify for the reduced sales charge
-the fund holds the extra shares purchased from the reduced sales charge in escrow
-once deposit is made, customer receives escrowed shares
-if customer has not completed the investment within 13 months, he will be given the choice of sending a check for the difference in sales charges or cashin in escrowed shares to pay the difference
-*may be backdated by up to 90 days to include prior purchases but may not cover more than 13 months in total*
Rights of Accumulation
-allow an investor to qualify for reduced sales charge
Differences include:
>are available for *subsequent investments and do not apply to initial transactions*
>allow the investor to *use prior share appreciation to qualify for breakpoints*
>do not impose time limits
Automatic Reinvestment of Distributions
-*customers may systematically reinvest dividends and capital gains* at *NAV* and may use them to buy full and fractional shares only if:
>shareholders who are not already participants in the reinvestment plan are given a separate opportunity to reinvest each dividend
>the plan is described in the prospectus
>the securities issuer bears no additional costs beyond those that it would have incurred in the normal payout of dividends
>shareholders are notified of the availability of the dividend reinvestment plan at least once every year
Combination Privileges
-a mutual fund sponsor frequently offers more than one fund and refers to these multiple offering as its family of funds
-*investor is allowed to combine separate investments in two or more funds within the same family to reach a breakpoint*
Exchange/Conversion Privileges
-allow an investor to convert an investment in one fund for an equal investment in another fund in the same family, *without incurring an additional sales charge*
-exchange is *considered a taxable event*
Classes of Shares
Investors can purchase the same underlying mutual fund shares in several ways. Generally, investors can purchase class A shares, class B shares, class c shares, or class d shares. The differences among these shares is how much and in what way investors will pay sales charges and related expenses
-*Class A: front-end load that can be reduced or eliminated by breakpoints
-Class B: back-end load that declines over time combined with 12b-1 fees
-Class C: 12b-1 fees charged quarterly
-Class D: level load plus a redemption fee*
-*Class B and C shares can NOT take advantage of breakpoints

Class A shares are purchased at NAV plus sales charge. Class B shares pay the sales charge upon redemption. Class D shares have a level load plus a redemption fee. Class C shares have only a level load (a 12b-1 fee) which is taken from net assets during the year.

Redemption of Fund Shares
-*MF must redeem shares within seven calendar days of receiving a written request for redemption*
-if customer holds the fund certificates, the MF must redeem shares within seven days of the date that the certificates and instruction to liquidate arrive at the custodian bank
-signature on written request must be guaranteed
Can be suspended only when:
>the NYSE is closed other than for a customary weekend or holiday closing
>trading on the NYSE has been restricted
>the SEC has ordered the suspension of redemptions for the protection of the company’s securities holders
Dividend Distributions
-MF may pay dividends to each shareholder like a corporation does
– Dividends *paid out out of fund’s Net Invesment Income*
-Net Invesment Income includes *gross investment income- dividend and interest income from securities held in the portfolio- minus operating expenses* (*does not include sales and advertising expenses)*
-qualified dividends from net investment income are taxed as per IRS standard code
The Conduit Theory
-triple taxation of investment income may be avoided *if the mutual fund qualifies under Subchapter M of the IRS*
-if MF acts as conduit (pipeline), for the distribution of net investment income, the fund may qualify as a regulated investment company, *subject to tax only on the amount of investment income the fund retains*
-Subchapter M:
*>requires a fund to distribute at least 90% of its net investment income to shareholders
>fund then pays taxes only on the undistributed 10%
>if distribution is 89%, must pay taxes on 100%*
Capital Gains Distributions
-Unrealized Gain or Loss:
>the appreciation or depreciation of portfolio securities if the fund does not sell the securities (no tax consequences)
-Realized Gain or Loss:
>when the fund sells the securities, affects shareholder taxes
>*if fund has held securities for more than one year, gains are taxed as long-term capital gains*

>*short-term gain is identified, distributed, and taxed at ordinary income tax rates*

– *A long-term capital gains distribution may not be made more often than once per year.*

* Whether a gain is distributed to the shareholder or retained by the fund, it must be reported for the year earned (accrued) (Year A) even if it is not yet paid by the fund to its shareholders (distributed in January of Year A+1).*

-*only realized gains are taxable to shareholders. Unrealized gains result in an increased NAV only*

Fund Yield
= *annual dividend paid/ current offering price*

-MF must disclose:
>general direction of the stock market for the period in question
>fund’s NAV at the beginning and the end of the period
>percentage change in the fund’s price during the period

*current yield calculations may be based only on income distributions for the preceding 12 months.* Gains distributions may not be included in yield calculations. *most mutual funds distribute dividends quarterly.* A mutual fund must disclose the source of a dividend payment if it is from other than retained or current income.

Ex-Dividend Date
-*ex-dividend date for mutual funds is set by the BOD*
-*day after record date*
Selling Dividends
-a RR may not encourage investors to purchase fund shares before a distribution because of this tax liability (violation of FINRA rules)
Form 1099
-details tax information related to distributions for the year
Cost Base
-amount of money invested
-upon liquidation, cost base represents a return of capital and is not taxed again
-*includes the shares’ total cost, including sales charges plus any reinvested dividend and capital gains distributions*

For tax purposes, the investor compares cost base to the amount of money received from selling the shares.
*If the amount received is greater than the cost base, the investor reports a taxable gain. If the amount received is less than the cost base, the investor reports a loss*

Methods investors could use to determine tax consequences
First In First Out (FIFO)
Share Identification
Average Basis
Dollar Cost Averaging
First In First Out (FIFO)
-when FIFO shares are sold, the cost of the shares held the longest is used to calculate the gain or loss
-in rising market, has adverse tax consequences
– default method used by IRS to determined tax consequences unless otherwise stated
Share Identification
-the investor keeps track of the cost each share purchased and uses this information when deciding which shares to liquidate
-liquidates shares that provide desired tax benefits
Average Basis
-calculates average basis by dividing the *total cost of all shares owned by the total number of shares*
Dollar Cost Averaging
-method of purchasing mutual fund shares, whereby a person invests identical amounts at regular intervals
-allows the individual to purchase more shares when prices are low and fewer shares when prices are high
-*effective if the average cost per share is less than the average price per share*
Withdrawal Plan Disclosure
-withdrawal plans are not guaranteed
-never promise an investor a guaranteed rate of return
-stress to the investor that it is possible to exhaust the account by overwithdrawing
-state that during a down market it is possible that the account will be exhausted if the investor withdraws even a small amount
-never use charts or tables unless the SEC specifically clears their use
Hedge Funds
-aggressively managed portfolios of investments that use advanced investment strategies generally intended for sophisticated investors

Common strategies:
>highly leveraged portfolios
>the use of short positions
>utilizing derivative products such as options and futures
>currency speculation
>commodity speculation
>investing in politically unstable international markets
-*investors must be accredited
> illiquid: some require investors to maintain an investment for a minimum length of time – this is commonly referred as lock-up provisions
> Commonly invested in Blank Check or Blind Pool companies

Hedge Funds Regulations
Hedge funds are unregulated
US laws do require that the majority of investors meet the test of a sophisticated investor.
They should be considered “accredited” investors
Spiders (SPRS)
– Standard & Poor’s depository receipts (SPDRs), called Spiders, are index funds designed to track the performance of an underlying investment portfolio.
-* Spiders pay quarterly cash dividends that represent, after expenses, dividends accumulated on the underlying stock portfolio*
– Most track price performance and dividend yield of S&P 500 companies
– Index tracking funds *are not investment company products, but they do have characteristics similar to both open-end and closed-end funds.*
– There are 9 select Sector index funds (e.g. consumer services, energy, and technology etc

Like Open-end funds, they create (issue) additional shares
Like closed-end funds, they trade like stock
– quart Div / track S&P500, continuous shares / intraday trading

Use of SPDRs
Investors use Spiders for:
? asset allocation;
? following industry trends;
? balancing a portfolio;
? speculative trading; and
? hedging.
Spiders vs MFs
Spider index funds are different from mutual funds in the following ways.
? Intraday trading—Investors do not have to wait until the end of a trading day to purchase or sell shares.
Shares trade throughout the day, making it easier for investors to react to market changes.
? Margin eligibility—Spider index funds can be bought on margin; same terms that apply to common stock.
? Short selling—Spider index funds can be sold short at any time during trading hours.
Index tracking funds have low portfolio turnover, which is a contributing factor to having low expense ratios.
The Q’s or QQQQ tracks the price performance of the Nasdaq 100 Trust, which is an exchange-traded fund (ETF) that trades on Nasdaq.
Leverage Funds
Attempt to deliver a multiple return of the benchmark index they are designed to track.
– For e.g. 2X Leverage Fund tries to deliver two times the return of whateever index it is tracking
– Double-edged swords: if benchmark index is falling that the fund will deliver a 2X times loss
Inverse funds
– Also known as reverse of short funds
– Attempt to deliver returns that opposite of the benchmark index they are tracking
Characteristics of Leverage and Inverse funds
1. Both leveraged and inverse index funds (leveraged or not) can be traded on an exchange.
2. Known as exchange-traded funds (ETFs).
3. Priced by supply and demand,
4. Can be purchased on margin, and bought and sold throughout the trading day
5. For those that are not exchange-traded, they would be priced, purchased, redeemed like all M/F shares.
Holding Company Depository Receipts (HOLDRS)
1. Holding company depository receipts (HOLDRS) are broker/dealer issued products that *trade on an exchange and are priced throughout the trading day.*
2. HOLDRS represent an investor’s ownership in the common stock or ADRs of specified companies in a particular industry.
3. HOLDRS preserve some ownership benefits related to owning the underlying stocks that ETFs do not.
4. HOLDRS allows investors to own a group of stocks as one asset or unbundle them to own each underlying security separately
.5. Once unbundled they could be traded individually.
6. *Gains can be deferred indefinitely, and losses can be taken at any time one wishes on each particular security.*
An investor will only pay taxes on gains that are realized, and unlike funds, there are no capital gains distributions.

– Exchange-traded investments
– Trade in round lots (100 shares).
– Not redeemable by their issuer like MFunds
– Distribute cash dividends generated by the companies held in the portfolio directly to the owners of the HOLDR shares.
– Allow great flexibility in managing the tax consequences of the investment because the securities can be unbundled and traded individually, thus taking loses when advantageous and deferring gains when advantageous.

Blank-check companies.
1. Known as special purpose acquisition companies (SPACS),
2. These are companies without business operations that raise money through IPOs so their shares trade publicly
3. Why? For the sole purpose of seeking out a business or combination of businesses.
4. Blank-check offerings do not identify any proposed investment intent.
Blind-pool companies.
1. Companies raise capital by selling securities without telling investors the specific use of the proceeds will be, but might target a particular industry or sector.
2. Blind-pool company will usually provide at least some indication of what general industry the funds will be invested in
Option Income Funds
– Fund owns common stock positions that they Write covered call options on
– Income is generated by the option
Funds of Funds
Mutual funds that invest in other mutual funds
Marketing Approaches used to promote MFs
Fund to Underwriter to Dealer to Investor
Fund to Underwriter to Investor
Fund to Investor
No Load Funds
Funds that offer shares with a 12b-1 fee of less than .25% may also be referred to as No Load Funds
Family of Funds
A M/F has multiple funds which can be used to reach a breakpoint.
Can also exchange or convert here as well
Withdrawal plans
In addition to lump-sum withdrawals, whereby customers sell all of their shares, mutual funds offer systematic withdrawal plans. Withdrawal plans are normally a free service.
– not all mutual funds offer withdrawal plans, but those that do may offer the plan alternatives described here.

1 Fixed Dollar: A customer may request the periodic withdrawal of a fixed dollar amount. Thus, the fund liquidates enough shares each period to send that sum. The amount of money liquidated may be more or less than the account earnings during the period.

2 Fixed Percentage or Fixed Share: here either a fixed number of shares or a fixed percentage of the account is liquidated each period.

3 Fixed Time: under a fixed-time withdrawal plan, customers liquidate their holdings over a fixed period.
– most mutual funds require a customer’s account to be worth a minimum amount of money before a withdrawal plan may begin.
– most funds discourage continued investment once withdrawals starts.

Voluntary accumulation plan
A voluntary accumulation plan allows a customer to deposit regular periodic investments on a voluntary basis. The plan is designed to help the customer form regular investment habits while still offering some flexibility.

– voluntary accumulation plans may require a minimum initial purchase and minimum additional purchase amounts.
– many funds offer automatic withdrawal from customer checking accounts to simplify contributions.
– If a customer misses a payment, the fund does not penalize him because the plan is voluntary. – – The customer may discontinue the plan at any time

Cancelation of Fund Shares
Because an open-end mutual fund makes a continuous public offering, a share is destroyed once a mutual fund share has been redeemed.

– unlike other corporate securities, mutual fund shares may not be sold to other owners.
– An investor purchasing mutual fund shares receives new shares.

Consequences of selling soon:
– *If a customer redeems mutual fund shares within seven business days of purchase, any fees or concessions earned by the firm for selling the shares must be returned to the underwriter. *
– This includes the portion payable to the representative who sold shares to the customer

Mutual Fund Tax Considerations
mutual fund investors must consider many tax factors when buying and selling mutual fund shares.

1 Withholding Tax
If an investor neglects or fails to include a Social Security number or tax Id number when purchasing mutual fund shares, the fund must withhold a percentage of the distributions to the investor as a withholding tax.

2 Taxation of Investment Returns
The taxation of investment returns may be summarized as follows.
? Qualified dividends are taxed at a percentage as determined by the IrS tax code depending on the investor’s ordinary income tax bracket.
? long-term capital gains distributions are taxed at a percentage as determined by the IrS tax code depending on the investor’s ordinary income tax bracket.
? Short-term capital gains distributions are taxed as ordinary income.

3 Exchanges Within a Family of Funds even though exchange within a fund family incurs no sales charge, the IrS considers a sale to have taken place, and if a gain occurs, the customer is taxed. This tax liability can be significant, and shareholders should be aware of this potential conversion cost.

Lifecycle funds
– Lifecycle funds use a predetermined asset mix that is tailored to meet investment objectives based on various time horizons or target dates. – – The target date is generally an investor’s expected retirement date.
– The objective is to strike an optimal balance between risk and return, as is appropriate for an investor, as they age and near retirement.
– The strategy assumes that the longer investors have before retirement, the more willing and able they will be to tolerate risk and endure price fluctuations.
– Generally, the investment mix within the fund portfolio becomes more conservative as the target date approaches and will be adjusted quarterly or on some other predetermined schedule.

– structured as “funds of funds” so that investing in one generally means that you are invested in a number of funds offered by the same fund family.
– companies offering lifecycle funds add new ones for distant target dates as they are needed and some are set up to have the lifecycle fund automatically role into one of the fund families’ more conservative funds, such as an income fund, when the target date is reached.

Funds of Hedge Funds
– registered mutual funds available to all investors that invest primarily in unregistered hedge funds known as funds of hedge funds.
– They can target and diversify among several hedge funds and, in this way, give non-accredited investors access to hedge funds.

– One benefit could be that lower initial investments might be required than when investing directly in a hedge fund.
– One risk to note is that like all mutual funds, the shares are not traded and that divesting of them can only occur if the mutual fund company redeems them.
– recommendations of funds of hedge funds would need to include the specific risks associated with hedge funds and the transfer of those risks that occurs when mutual funds invest in hedge funds.

Acronyms and Formula
Investment Company Registration
40%: 100,000, 100, Ob, 90

Registration Requirements
type : plans (raise, invest, concentrate) : affiliated personnel (experience of directors dating by to 5 yrs)

MF Summary Section
Corporate Offensive Security Certified Professional
Costs, Obj, Strategies, compensation – IC, PM, and IN, Portfolio

Restrictions on MF
Missouri State Joint Committee
margin/ short/Joint account / Collateral after 30 days

Hires/ policy / Objective/ Type

Expense Ratio
= fund’s expenses/ average net assets

Fund’s NAV = Assets (cash+current values of securities) – liabilities

-NAV per share = Fund’s NAV/ Number of shares outstanding

POP – NAV = sales charge ($ amount)

Sales charge ($ amount)/ POP = sales charge %

NAV/ 100% – sales charge % = POP*

Concession = POP – Dealers’ discount

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