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Chapter 16 Investing in Mutual Funds

True/False Questions
T

1. In late 2001, there were over 8,300 mutual funds, and the number continues to
increase each year.

Answer: True Difficulty: Easy LO: 1 Page: 525


T

2. The major reasons why investors purchase mutual funds are professional
management and diversification.

Answer: True Difficulty: Easy LO: 1 Page: 525


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3. Because of professional management, there is no need for the individual investor


to evaluate a mutual fund investment.

Answer: False Difficulty: Med LO: 1 Page: 525


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4. The diversification of mutual funds spells safety, because an occasional loss


incurred with one investment is usually offset by gains from other investments.

Answer: True Difficulty: Med LO: 1 Page: 525


T

5. A closed-end fund is a mutual fund in which shares are issued only when the fund
is organized.

Answer: True Difficulty: Easy LO: 1 Page: 525


T

6. Today, there are more closed-end funds than there are open-end funds.

Answer: False Difficulty: Med LO: 1 Page: 525-527


T

7. Shares in an open-end fund are redeemed by the investment company at the


request of the investor.

Answer: True Difficulty: Easy LO: 1 Page: 527

T
F
8.
An exchange-traded fund, commonly referred to as an EFT, is a
fund that invests in the stocks contained in a specific stock index.
Answer: True Difficulty: Easy LO: 1 Page: 525
T

9. Because an exchange-traded fund mirrors the same stocks that are contained in a
specific stock index, there is more need for a professional manager.

Answer: False Difficulty: Med LO: 1 Page: 527


T

F 10. There are more exchange-traded funds than there are open-end mutual funds.
Answer: False Difficulty: Med LO: 1 Page: 527

F 11. The net asset value for a mutual fund share is calculated by dividing the value of
the fund's portfolio by the fund's liabilities.
Answer: False Difficulty: Hard LO: 1 Page: 527

F 12. A load fund is a mutual fund in which investors pay a commission every time they
sell and redeem shares.
Answer: False Difficulty: Med LO: 1 Page: 528

F 13. For a load fund, the average commission usually ranges between 3 and 5 percent
of the purchase price for investments under $10,000.
Answer: True Difficulty: Easy LO: 1 Page: 528

F 14. A no-load fund is a mutual fund in which no sales charge is paid by the individual
investor to purchase shares.
Answer: True Difficulty: Easy LO: 1 Page: 528

F 15. For a mutual fund, the typical yearly management fee ranges from 2.5 to 5 percent
of total dollar amount invested.
Answer: False Difficulty: Med LO: 1 Page: 529

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F
16.
A contingent deferred sales load fee is a 1 to 5 percent charge that
shareholders pay when they withdraw their investment from a mutual fund.
Answer: True Difficulty: Easy LO: 1 Page: 528
T

F 17. Today, all mutual funds charge the 12b-1 fee to offset marketing and distribution
costs.
Answer: False Difficulty: Med LO: 1 Page: 529

F 18. When you invest in Class A shares, you pay commissions when you sell your
mutual fund shares.
Answer: False Difficulty: Med LO: 1 Page: 529

F 19. Class C shares, because of their ongoing, higher 12b-1 fees, are often more
expensive than Class A or Class B shares over a long period of time.
Answer: True Difficulty: Med LO: 1 Page: 529

F 20. All information related to management fees, contingent deferred sales fees, 12b-1
fees, and other expenses are contained in a mutual fund's fee table.
Answer: True Difficulty: Med LO: 1 Page: 529

F 21. The managers of mutual funds tailor their investment portfolios to the investment
objectives of their customers.
Answer: True Difficulty: Easy LO: 2 Page: 531

F 22. Mutual funds that apportion their investments among common stocks and bonds
are referred to as small cap funds.
Answer: False Difficulty: Med LO: 2 Page: 532

F 23. Mutual funds that invest in smaller, lesser known companies that offer higher
growth potential are referred to as a sector fund.
Answer: False Difficulty: Easy LO: 2 Page: 532

24.

High-yield bond funds are sometimes referred to as junk bond

funds.
Answer: True Difficulty: Med LO: 2 Page: 532
T

F 25. A mutual fund that provides tax-exempt interest income is referred to as a longterm U.S. bond fund.
Answer: False Difficulty: Easy LO: 2 Page: 533

F 26. Asset allocation funds invest in various asset classes, but not limited to, stocks,
bonds, and other fixed-income securities.
Answer: True Difficulty: Med LO: 2 Page: 533

F 27. The family of funds concept makes it convenient for shareholders to switch their
investments among funds as different funds offer more potential.
Answer: True Difficulty: Med LO: 3 Page: 533

F 28. When investing in a managed mutual fund, ultimately the fund manager is
responsible for the fund's success.
Answer: True Difficulty: Easy LO: 3 Page: 534

F 29. Because an index fund is a mirror image of a specific index, the dollar value of a
share in an index fund increases when the index increases.
Answer: True Difficulty: Easy LO: 3 Page: 534

F 30. Typical expense ratios for an index fund are higher than for managed funds.
Answer: False Difficulty: Med LO: 3 Page: 534

F 31. In a newspaper quotation, NAV stands for "not accessible value."


Answer: False Difficulty: Med LO: 3 Page: 538

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F
fee is charged.

32.

In a newspaper quotation, the letter "P" means a 12b-1 distribution

Answer: True Difficulty: Med LO: 3 Page: 537


T

F 33. An investment company sponsoring a mutual fund must furnish shareholders a


prospectus each year.
Answer: False Difficulty: Hard LO: 3 Page: 538

F 34. While advisory services provide detailed information on common and preferred
stocks, there are no advisory services that provide information on mutual funds.
Answer: False Difficulty: Easy LO: 3 Page: 541

F 35. Investors in closed-end, exchange-traded funds, and open-end funds can make
money by purchasing shares at a low price and then selling them at a higher price.
Answer: True Difficulty: Hard LO: 4 Page: 544

F 36. Although mutual funds are popular among individual investors, most people do
not use them as part of an IRA or retirement account.
Answer: False Difficulty: Med LO: 4 Page: 543

F 37. Typically, you must invest at least $15,000, to open a mutual fund account.
Answer: False Difficulty: Easy LO: 4 Page: 543

F 38. Income dividends are the earnings a fund pays to shareholders after it has
deducted expenses from its dividend and interest income.
Answer: True Difficulty: Easy LO: 4 Page: 544

F 39. Capital gain distributions result when you decide to sell shares in a mutual fund at
a price higher than you paid.
Answer: False Difficulty: Med LO: 4 Page: 544

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T
F
40.
While mutual fund income dividends are subject to taxation,
capital gain distributions are not subject to taxation.
Answer: False Difficulty: Med LO: 4 Page: 544-545
T

F 41. Tax information for mutual funds is reported as part of the year-end statement or
IRS Form 1099-DIV.
Answer: True Difficulty: Med LO: 4 Page: 544

F 42. To purchase shares in an open-end fund, you may use four options: regular
accounts, voluntary savings plans, contractual savings plans and reinvestment
plans.
Answer: True Difficulty: Med LO: 4 Page: 547

F 43. In order to sell shares in a closed-end fund, an investor must wait until the
investment company is ready to repurchase the investor's shares.
Answer: False Difficulty: Hard LO: 4 Page: 548

F 44. When you decide to redeem shares in an open-end mutual fund, the only option is
to sell a specific number of shares.
Answer: False Difficulty: Easy LO: 4 Page: 548

Multiple Choice Questions


45. Which of the following statements is false?
A) Investors purchase mutual funds for diversification.
B) Investors purchase mutual funds because of professional management.
C) Investors who purchase mutual funds are guaranteed a higher rate of return than a
comparable investment in stocks or bonds.
D) Professional mutual fund managers work for an investment company.
E) Even the best portfolio managers sometimes make mistakes.
Answer: C Difficulty: Med LO: 1 Page: 524

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46.
A)
B)
C)
D)
E)

Approximately ____________ percent of all mutual funds are closed-end funds.


3
6
15
20
30

Answer: B Difficulty: Med LO: 1 Page: 525


47. Which of the following statements is false?
A) an exchange-traded fund invests in the stocks contained in a stock index.
B) With an exchange-traded fund, an investor can purchase as little as one share.
C) The values of shares in an exchange-traded fund tend to mirror the performance of
the index.
D) With an exchange-traded fund, there is more need for a portfolio manager to make
decisions.
E) Exchange-traded funds are increasing in popularity.
Answer: D Difficulty: Med LO: 1 Page: 525-527
48. There are about _____ exchange-traded funds.
A) 25
B) 50
C) 100
D) 250
E) 500
Answer: C Difficulty: Med LO: 1 Page: 527
49. Approximately ____________ percent of all mutual funds are open-end funds.
A) 5
B) 6
C) 30
D) 72
E) 93
Answer: E Difficulty: Easy LO: 1 Page: 527

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50.
A mutual fund in which shares are issued only when the fund is organized is
called a(n) ____________ fund.
A) closed-end
B) open-end
C) load
D) no-load
E) convertible
Answer: A Difficulty: Easy LO: 1 Page: 525
51. A mutual fund in which new shares are issued and redeemed by the investment company
at the request of investors is called a(n) ____________ fund.
A) closed-end
B) open-end
C) load
D) no-load
E) convertible
Answer: B Difficulty: Easy LO: 1 Page: 527
52. The value of the mutual fund's portfolio minus the mutual fund's liabilities divided by the
number of shares outstanding is called the
A) book value.
B) outstanding balance.
C) per share value.
D) net asset value.
E) accounting value.
Answer: D Difficulty: Med LO: 1 Page: 527
53. The Capitalist Mutual Fund's portfolio is valued at $45 million. The fund has liabilities of
$3 million, and the investment company sponsoring the fund has issued 1,600,000 shares.
What is the fund's net asset value?
A) $100
B) $26.25
C) $52.50
D) $3.75
E) $1
Answer: B Difficulty: Hard LO: 1 Page: 527

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54.
The All-Star Basic Value Fund's portfolio is valued at $210 million. The fund has
liabilities of $5 million, and the investment company sponsoring the fund has issued 16,400,000
shares. What is the fund's net asset value?
A) $25.00
B) $21.00
C) $16.40
D) $12.50
E) $ 5.00
Answer: D Difficulty: Med LO: 1 Page: 527
55. For most mutual funds, the net asset value is calculated
A) yearly.
B) quarterly.
C) weekly.
D) daily.
E) whenever an investor calls and requests a price quote.
Answer: D Difficulty: Med LO: 1 Page: 528
56. The New American Enterprise Mutual Fund's portfolio is valued at $120,000,000. The
fund has liabilities of $4,000,000, and the investment company sponsoring the fund has
issued 5,800,000 shares. What is the fund's net asset value?
A) $120
B) $58
C) $40
D) $30
E) $20
Answer: E Difficulty: Hard LO: 1 Page: 527
57. A mutual fund in which investors pay a commission every time they purchase shares is
called a(n) ____________ fund.
A) closed-end
B) open-end
C) load
D) no-load
E) convertible
Answer: C Difficulty: Easy LO: 1 Page: 528

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58.
The commission charge for purchasing shares of a load fund that imposes an upfront commission charge is ____________ percent.
A) 0.50 to 1
B) 1 to 2
C) 2 to 4
D) 5 to 6 1/2
E) as high as 8 1/2
Answer: E Difficulty: Med LO: 1 Page: 528
59. When an investor purchases shares in a load fund, the average sales charge is usually
____________ percent.
A) between 0.5 to 2
B) between 1 and 3
C) between 3 and 5
D) between 5 and 7
E) in excess of 8 1/2
Answer: C Difficulty: Med LO: 1 Page: 528
60. Mary Cooper just purchased 100 shares in the All-American Fidelity Fund. The purchase
cost for each share was $20. If this fund charges a 5 percent load, what is the total amount
of commission she will pay the investment company?
A) $100
B) $1000
C) $2,000
D) $2,100
E) It is impossible to calculate Ms. Cooper's total investment with this information
Answer: A Difficulty: Hard LO: 1 Page: 528
61. Bob Newsome purchased 250 shares of the New Horizons Growth Fund. The purchase
cost for each share at the time of purchase was $30. If this fund charges a 3 percent load,
what is the commission amount he will pay the investment company?
A) $3
B) $30
C) $100
D) $225
E) $250
Answer: D Difficulty: Hard LO: 1 Page: 528

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62.
A mutual fund in which no sales charge is paid by the individual investor is called
a(n) ____________ fund.
A) closed-end
B) open-end
C) load
D) no-load
E) convertible fund.
Answer: D Difficulty: Easy LO: 1 Page: 528
63. The management fee for most mutual funds ranges between ____________ percent.
A) 0.25 to 2
B) 2 to 3
C) 3 to 4
D) 5 to 6 1/2
E) 7 to 8 1/2
Answer: A Difficulty: Med LO: 1 Page: 529
64. The average management fee for all mutual funds is
A) less than 0.25 percent.
B) 0.25 percent to 0.50 percent.
C) 0.50 to 1.25 percent.
D) 1.25 to 2.50 percent.
E) 2.50 to 5.00 percent.
Answer: C Difficulty: Med LO: 1 Page: 529
65. A 1 to 5 percent fee that investors pay when they withdraw their investment from a
mutual fund is called a(n)
A) withdrawal fee.
B) sales fee.
C) contingent deferred sales load.
D) unload fee.
E) load fee.
Answer: C Difficulty: Med LO: 1 Page: 528

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66.
When Pete Mills went to withdraw $5,000 from the Nationwide Fidelity Mutual
fund, he was informed that the fund would charge 5 percent of the amount withdrawn. What is
the dollar amount of the withdrawal charge?
A) $2,500
B) $500
C) $250
D) $25
E) It is impossible to calculate the withdrawal charge with this information.
Answer: C Difficulty: Hard LO: 1 Page: 528
67. A fee that some investment companies charge for marketing and distributing a mutual
fund is called a
A) 14A-1 fee.
B) 12b-1 fee.
C) 18-2 fee.
D) 21-AB fee.
E) None of the above answers are correct.
Answer: B Difficulty: Med LO: 1 Page: 529
68. The typical marketing and distribution fees that a mutual fund passes on to a shareholder
may be
A) 0.10 percent of the fund's yearly sales.
B) 0.25 percent of the fund's assets per year.
C) 0.50 percent of the fund's yearly sales.
D) 0.75 percent of the fund's assets on an annual basis.
E) approximately one percent of the fund's assets per year.
Answer: E Difficulty: Med LO: 1 Page: 529
69. Another name for a mutual fund that charges a contingent deferred sales load is a(n)
____________ fund.
A) A
B) B
C) C
D) D
E) 12b-1
Answer: B Difficulty: Med LO: 1 Page: 529

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70.
Another name for a mutual fund that doesn't charge a load, but does charge an
ongoing higher 12b-1 fee is a(n) ____________ fund.
A) A
B) B
C) C
D) D
E) minimal load
Answer: C Difficulty: Med LO: 1 Page: 529
71. All the different management fees and fund's operating costs are often referred to as a(n)
A) investment ratio.
B) expense ratio.
C) financial ratio.
D) expense turnover.
E) management ratio.
Answer: B Difficulty: Med LO: 1 Page: 529
72. Many financial planners recommend that investors pick a mutual fund with an expense
ratio that is
A) 1 percent or less.
B) between 1 and 2 percent.
C) between 2 and 3 percent.
D) between 3 and 4 percent.
E) over 4 percent.
Answer: A Difficulty: Med LO: 1 Page: 529
73. A mutual fund that invests in common stocks and bonds with the primary objective of
conserving capital and providing income is called a(n) ____________ fund.
A) balanced
B) growth
C) industry
D) income
E) money market
Answer: A Difficulty: Med LO: 2 Page: 533

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74.
A mutual fund that invests in common stocks of rapidly growing corporations
with higher-than-average revenue and earnings growth is called a(n) ____________ fund.
A) balanced
B) growth
C) industry
D) income
E) money market
Answer: B Difficulty: Med LO: 2 Page: 532
75. A mutual fund that invests in stocks that provide a predictable source of dividend income
and the potential for dollar appreciation is called a(n) ____________ fund.
A) balanced
B) growth and income
C) industry
D) sector
E) money market
Answer: B Difficulty: Med LO: 2 Page: 532
76. A mutual fund that invests in investment grade corporate debt with maturities between 5years and 10-years maturities is called a(n) ____________ fund.
A) balanced
B) growth
C) sector
D) income
E) intermediate corporate bond
Answer: E Difficulty: Easy LO: 2 Page: 532
77. A mutual fund that invests in the common stocks of companies in the same industry is
called a(n) ____________ fund.
A) growth-income
B) income
C) sector
D) small-cap
E) money market
Answer: C Difficulty: Med LO: 2 Page: 532

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78.
A mutual fund that invests in companies outside the United States is called a(n)
____________ fund.
A) growth-income
B) income
C) international
D) industry
E) global market
Answer: C Difficulty: Med LO: 2 Page: 532
79. A municipal bond fund
A) is too risky for most investors.
B) provides investors with tax-free income.
C) invests in bonds that are backed by the federal government.
D) is a risk-free investment.
E) are not rated because they are short-term investments.
Answer: B Difficulty: Med LO: 2 Page: 533
80. Last month Nellie Jacobson's divorce became final. As part of the settlement, she
received $150,000. She would like to invest in mutual funds, but since she is 62 years
old, she is concerned with the safety of her "nest egg." Which of the following mutual
funds would you recommend?
A) growth fund
B) small cap fund
C) high-yield bond fund
D) international fund
E) U. S. bond fund
Answer: E Difficulty: Med LO: 2 Page: 532-533
81. Martin Campbell wants to invest in mutual funds, but is also worried about
diversification. Which fund would you recommend?
A) income fund
B) long-term corporate bond fund
C) U. S. government bond fund
D) money market fund
E) asset allocation fund
Answer: E Difficulty: Med LO: 2 Page: 533

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82.
A)
B)
C)
D)
E)

When one investment company manages a group of mutual funds, it is called a(n)
family of funds.
exchange fund.
diversification fund.
versatility fund.
group of funds.

Answer: A Difficulty: Med LO: 2 Page: 533


83. An individual who helps investors decide when to switch their investment from one fund
to another fund is called a(n)
A) financial planner
B) fund evaluator.
C) opportunity timer.
D) market timer.
E) fund consultant.
Answer: D Difficulty: Med LO: 2 Page: 533
84. Which of the following statements is false?
A) Market timers charge 1 percent to 3 percent of the dollar value of the funds they
manage.
B) Early research indicates that market timers must be evaluated as a group.
C) A large number of investors are now using market timers.
D) The true test of market timers is the ability to increase the investor's return during
good times and keep that return during bad times.
E) A market timer helps investors decide when to switch from one fund to another.
Answer: B Difficulty: Hard LO: 2 Page: 533
85. Which of the following statements is false?
A) The responsibility for choosing the right mutual fund rests with the individual
investor.
B) Professional fund managers do make mistakes.
C) Although investing in mutual funds provides professional management, individual
investors should continually evaluate their mutual fund investments.
D) There is no need to evaluate mutual fund investments because investment companies
hire the best professional managers they can to manage their funds.
E) Individual investors should be involved in choosing a mutual fund because they know
how the objectives of a mutual fund match their own investment objectives.
Answer: D Difficulty: Med LO: 2 Page: 534

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86.
Which of the following statements is true?
A) Most mutual funds are managed funds.
B) The role of a fund manager is not important because the investment company is
always changing managers.
C) If a fund has performed well under its present manager over a 5-year, 10-year, or
longer period, it is time to sell the fund.
D) Managed funds are usually index funds that include a high concentration of defensive
stocks.
E) A team of managers is always better than a single fund manager.
Answer: A Difficulty: Med LO: 3 Page: 534
87. Which of the following statements is false?
A) As an investor, you should be concerned with how long a fund manager has been
managing a mutual fund.
B) Often, a fund's success is tied to the manager's ability to buy and sell securities in the
fund.
C) If a manager has been managing a fund for 5 or 10 years, it is time to change
managers and get someone with new ideas.
D) Ultimately, the fund manager is responsible for a fund's success.
E) Managed funds may be open-end funds or closed-end funds.
Answer: C Difficulty: Med LO: 3 Page: 534
88. Over many years, index funds have outperformed almost _____ percent of all managed
funds.
A) 100
B) 85
C) 70
D) 50
E) 40
Answer: B Difficulty: Med LO: 3 Page: 534
89. The typical expense ratio for an index fund is
A) 0.50 percent or less.
B) between 0.50 and 1 percent.
C) between 1 and 2 percent.
D) between 2 and 3 percent.
E) Over 5 percent
Answer: A Difficulty: Med LO: 3 Page: 534

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90.
Which of the following is not a true statement?
A) Many investors have found a wealth of information about mutual funds investments
on the Internet.
B) It is possible to obtain market values for a mutual fund by using the Internet.
C) Most investment companies that sponsor mutual funds have a Web page.
D) It is impossible to obtain online information about a mutual fund by accessing the
Web page for one of the professional advisory services.
E) A mutual fund's Web site will provide information about how to open an account,
current market quotes, and other information about a specific fund.
Answer: D Difficulty: Hard LO: 3 Page: 535-536
91. In a newspaper quotation, which of the following letters would indicate if a mutual fund
has a redemption charge?
A) NL
B) r
C) p
D) t
E) It is impossible to tell if there is a redemption charge by looking in the newspaper.
Answer: B Difficulty: Med LO: 3 Page: 537
92. In a newspaper quotation, which of the following letters would indicate if a mutual fund
has a 12b-1 fee?
A) NL
B) r
C) p
D) t
E) It is impossible to tell if there is a 12b-1 fee by looking in the newspaper.
Answer: C Difficulty: Hard LO: 3 Page: 537
93. An investment company sponsoring a mutual fund must give potential investors a
A) 12b-1 report.
B) prospectus.
C) disclosure/evaluation form.
D) redemption fee sheet.
E) copy of the annual mutual funds evaluation provided by Changing Times magazine.
Answer: B Difficulty: Med LO: 3 Page: 538

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94.
A)
B)
C)
D)

As a shareholder in a mutual fund, you should receive a(n)


annual report.
12b-1 report.
redemption fee sheet.
letter from the president of the investment company that details what the fund's
objectives are.
E) copy of the annual mutual funds evaluation provided by Changing Times magazine.
Answer: A Difficulty: Med LO: 3 Page: 539
95. Which of the following publications does not provide readers with an annual survey of
mutual funds?
A) Business Week
B) Current Business Survey
C) Forbes
D) Kiplinger's Personal Finance Magazine
E) Money
Answer: B Difficulty: Med LO: 3 Page: 539
96. Which of the following professional advisory services would not provide information
about a potential mutual fund?
A) A.M Best
B) Lipper Analytical Services
C) Morningstar, Inc.
D) Value Line
E) Wiesenberger Investment Companies
Answer: A Difficulty: Med LO: 3 Page: 541
97. Which of the following statements is false?
A) The purpose of investing in a closed-end or open-end mutual fund is to earn a
financial return.
B) Income dividends are the earnings that a fund pays to shareholders from its dividend
and interest income.
C) Capital gain distributions are the payments made to a fund's shareholders that result
from the sale of securities in the fund's portfolio.
D) It is possible to make money on a mutual fund by purchasing shares at a high price
and then selling them at a low price at a later date.
E) All of the above statements are true.
Answer: D Difficulty: Med LO: 4 Page: 540

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98.
During 2002, Lincoln Masters received income dividends of $850 and capital gain
distributions of $540. Based on this information,
A) both amounts must be included as taxable income.
B) only the dividends are taxable.
C) only the capital gains are taxable.
D) both amounts are tax exempt.
E) It is impossible to determine the tax consequences for dividend income and capital
gain distributions unless the shares of the mutual fund are sold to another investor.
Answer: A Difficulty: Hard LO: 4 Page: 544-545
99. Income dividends and capital gain distributions are
A) exempt from taxation.
B) subject to federal taxation.
C) subject to federal taxation after the first $1,000.
D) subject to federal taxation after the first $5,000.
E) subject to federal taxation after the first $10,000.
Answer: B Difficulty: Med LO: 4 Page: 544-545
100. The most popular and least complicated method of purchasing shares in an open-end
mutual fund is through a
A) regular account transaction.
B) voluntary savings plan.
C) contractual savings plan.
D) minimum withdrawal plan.
E) free contract plan.
Answer: A Difficulty: Med LO: 4 Page: 547
101. A mutual fund that requires investors to make regular purchases over a specified period
of time is called a
A) regular account.
B) voluntary savings plan.
C) contractual savings plan.
D) minimum withdrawal plan.
E) free contract plan.
Answer: C Difficulty: Med LO: 4 Page: 547

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102. Because of up front charges, many financial experts and government agencies are
critical of
A) regular accounts.
B) voluntary savings plans
C) contractual savings plans.
D) minimum withdrawal plans.
E) free contract plans.
Answer: C Difficulty: Hard LO: 4 Page: 547
103. If an investor uses a reinvestment plan to invest income dividends and capital-gain
distributions,
A) both the income dividends and capital-gain distributions are tax-exempt.
B) only the income dividends are tax-exempt.
C) only the capital-gain distributions are tax-exempt.
D) both the income dividends and capital-gain distributions are taxable at the end of the
tax year.
E) Given the above information, it is impossible to determine if either type of income is
taxable.
Answer: D Difficulty: Med LO: 4 Page: 547
104. Which of the following is not a withdrawal option for a mutual fund?
A) The investor may withdraw a specified, dollar amount each investment period.
B) The investor may liquidate or "sell off" a certain number of shares each investment
period.
C) The investor can withdraw a fixed percentage of asset growth.
D) The investor can withdraw all income that results from dividends and capital gains
earned by the mutual fund during an investment period.
E) The investor must wait five years, and then can withdraw 10 percent of the asset
growth each year until the fund is exhausted.
Answer: E Difficulty: Hard LO: 4 Page: 548

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Essay Questions
105. Why do investors purchase mutual funds instead of purchasing stocks, bonds, or other
investments on their own?
Difficulty: Med LO: 1 Page: 524-525
Answer:
The major reasons why investors purchase mutual funds are professional management
and diversification. Most investment companies do everything possible to convince
individual investors that they can do a better job of picking securities than individuals
can. In reality, they do have professional portfolio managers with years of experience that
spend a lot of time picking just the right securities for their mutual funds. Of course, it
should be pointed out that even the best managers sometimes make mistakes. The
diversification of mutual funds spells safety; because an occasional loss incurred with one
investment is usually offset by gains from other investments.
106. Explain the difference between a load fund and a no-load fund. From a performance
standpoint, is there a significant difference between mutual funds that charge
commissions and those that do not?
Difficulty: Med LO: 1 Page: 528
Answer:
A load fund is a mutual fund in which investors pay a commission every time they
purchase shares. Typical charges may be as high as 8 1/2 percent for purchases under
$10,000. A no-load fund is a mutual fund in which no sales charge is paid by the
individual investor. A no-load fund doesn't charge commissions when you buy shares
because they have no salespeople. If you want to buy shares of a no-load fund, you must
deal directly with the investment company. Many financial analysts indicate that there is
no significant difference between mutual funds that charge commissions and those that
do not. Since no-load funds offer the same investment opportunities that load funds offer,
an investor should investigate them further before deciding which type of mutual fund is
best.

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107. Cindy and John Appleby just inherited $30,000 and would like to invest the
money in a conservative mutual fund. Since they have never invested in mutual funds, they ask
for your help. In your own words, describe the factors that can be used to evaluate a mutual fund
investment.
Difficulty: Med LO: 3 Page: 534-543
Answer:
The following factors can be used to evaluate a potential investment in mutual funds: (1)
the Internet; (2) current newspaper quotations; (3) the fund's prospectus; (4) the fund's
annual report; (5) financial publications that include Business Week, Kiplinger's Personal
Finance Magazine, Forbes, Money, and other finance- or consumer-oriented magazines;
and (6) professional advisory services. They should also decide if they want to invest in a
managed or index fund.
108. Describe either the purchase options or withdrawal options that can be used to invest in
or withdraw money from the investment company that sponsors an open-end mutual
fund.
Difficulty: Med LO: 4 Page: 546-548
Answer:
To purchase shares in an open-end mutual fund, you may use these options: regular
account transactions, voluntary savings plans, contractual savings plans, and reinvestment
plans. The Securities and Exchange Commission, other government agencies, and
financial planners are especially critical of the contractual savings plans because if an
investor drops out of this type of plan, he or she sacrifices the prepaid or front-end load
charges. Shares in an open-end fund can be sold on any business day to the investment
company that sponsors the fund. In this case, shares are redeemed at their net asset value.
In addition, most funds have provisions that allow investors with a minimum net asset
value of at least $5,000 to use four options to systematically withdraw money. First,
investors may withdraw a specified fixed dollar amount each investment period. Second,
investors may sell off a certain number of shares each investment period. Third, investors
may withdraw a fixed percentage of asset growth. Fourth, investors may withdraw all
income that results from interest, dividends, and capital gains earned during an
investment period.

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