File: ch03, Chapter 3: INDIRECT INVESTING

Type: Multiple Choice

1. Which of the following is not one of the four types of investment companies?

a. Stock brokerage companies

b. Unit investment trusts
c. Closed-end funds
d. Mutual funds

Ans: a
Difficulty: Easy
Response: Stock brokerage accounts are used for direct investments. All three types of investment
companies provide indirect investments.
Ref: What is an Investment Company?

2. Which of the following statements regarding mutual funds is most accurate?

a. Mutual funds are designed for major institutional investors, such as endowments.
b. Only the wealthiest individual investors own mutual funds.
c. Mutual funds invest only in very safe assets, such as government bonds.
d. Mutual funds have increased assets under management rapidly in the last 40 years.

Ans: d
Difficulty: Easy
Response: Most mutual funds are designed for individual investors, and more than two in five of all
U.S. households now own mutual funds. Mutual funds invest in corporate stocks and bonds, as
well as government securities. They have become extremely popular investment vehicles.
Ref: Three Major Types of Investment Companies

3. What is the legal definition of an investment company?

a. Any company that handles investments

b. A financial company that sells shares of itself to the public, using the funds to buy securities
c. A company in which the general public can invest
d. A company that advises on mergers and acquisitions

Ans: b
Difficulty: Easy
Ref: What is an Investment Company?

4. Which of the following is considered a mutual fund complex?

a. Fidelity Equity Income Fund

b. Kaufmann Fund
c. Morningstar
d. Fidelity Investments

Ans: d
Difficulty: Medium
Response: Fidelity Equity Income Fund and Kaufmann Fund are examples of mutual funds.
Morningstar provides a third-party rating service on mutual funds. Fidelity Investments is the
company sponsoring the Fidelity Equity Income Fund and a host of other mutual funds.
Ref: The Details of Indirect Investing

5. Which of the following is not an advantage of investing in mutual funds?

a. Professional management
b. Guarantee against loss
c. Diversity by investing in many securities
d. Daily liquidity

Ans: b
Difficulty: Easy
Response: Mutual funds provide daily liquidity, investment diversification and professional
management, but not a guarantee against loss.
Ref: What is an Investment Company?

6. Why would an investor want to buy an unmanaged investment like a unit investment trust
(UIT)?

a. Fund managers often underperform market indexes.

b. Investors can rapidly change the underlying investments, as conditions change.
c. Unit investment trusts are “buy and hold” vehicles designed for capital preservation.
d. The unit investment trust keeps the interest (or dividends) for the investors.

Ans: c
Difficulty: Medium
Response: UITs are generally designed to be bought and held, for purposes of capital preservation.
Ref: What is an Investment Company?

7. ETF’s provide all of the following advantages over mutual funds except?

a. They frequently have lower operating expenses.

b. They can be bought and sold throughout the trading day.
c. They are more tax efficient.
d. They have a longer history of performance.

Ans: d
Difficulty: Difficult
Response: While ETF’s have many advantages over mutual fund investing, mutual funds have
clearly been in existence for a much longer period of time.
Ref: Three Major Types of Investment Companies

8. What is “closed” in a closed-end investment company?

a. The sales of shares in the company are "closed" after the initial public offering.
b. The sales of shares in the company are open only to the officers, "closed" to all others.
c. The company invests in some appropriate investments, then "closes" operation.
d. The market value of the company is "close" to the net asset value.

Ans: a
Difficulty: Medium
Response: The existing shares of the investment company are traded on exchanges: no new shares
are created.
Ref: Three Major Types of Investment Companies

9. Which type of investment company is the most popular with investors?

a. Unit investment trusts

b. Closed-end investment companies
c. Open-end investment companies
d. Exchange-traded funds

Ans: c
Difficulty: Medium
Response: The two funds with the least funds under management are unit investment trusts and
closed-end funds. UITs have a very small amount of investors’ assets versus closed-end funds.
ETFs have grown tremendously in recent years; however, they still lag open-end funds by a
substantial amount.
Ref: Three Major Types of Investment Companies

10. Which of the following is a characteristic of mutual funds?

a. Mutual funds have a higher return than closed-end funds or unit investment trusts.
b. Investors can get their money out at that day's net asset value.
c. Most mutual funds have very large minimum investments, such as $100,000 or $1 million.
d. Mutual funds are guaranteed by the sponsoring company, such as Fidelity.

Ans: b
Difficulty: Easy
Ref: Three Major Types of Investment Companies

11. Which of the following properly ranks different types of mutual funds, starting from the
least risk to the highest risk?
a. International stocks, long term bonds, money market
b. Long term bonds, short term bonds, aggressive stocks
c. Short term bonds, long term bonds, balanced
d. Industry specific, international, long term bonds

Ans: c
Difficulty: Easy
Ref: Three Major Types of Investment Companies

12. Which of the following is not a type of equity fund?

a. Money market mutual funds

b. Growth funds
c. Hybrid funds
d. World equity funds

Ans: a
Difficulty: Easy
Ref: Three Major Types of Investment Companies

13. Which of the following statements concerning index funds is not true?

a. The fund managers purchase the components of a standard index, such as the S&P 500.
b. Index funds generally have lower fees than actively managed funds.
c. Index funds often out-perform actively managed funds.
d. Index funds are managed by the sponsors of the index in question.

Ans: d
Difficulty: Easy
Response: An index fund, by definition, is not actively managed. They are generally not affiliated
with the index sponsors.
Ref: Types of Mutual Funds

14. Which of the following is not a way to buy shares in open-end mutual funds?

a. Directly from the fund company

b. Indirectly, through stock brokers or financial planners
c. Reinvesting dividends from existing shares
d. From another investor through a broker

Ans: d
Difficulty: Easy
Response: Mutual funds are typically available for purchase from any number of different avenues,
but are not purchased from other investors.
Ref: The Details of Indirect Investing
15. Which of the following would have the lowest annual operating expenses?

a. State Street High Income Fund

b. Janus Venture Fund
c. Vanguard Total Stock Market ETF
d. Fidelity Equity Income Fund

Ans: c
Difficulty: Easy
Response: State Street High Income Fund, Janus Venture Fund and Fidelity Equity Income Fund
are all mutual funds, which have higher annual fees than ETF’s because of the costs associated with
actively managing versus indexing.
Ref: Three Major Types of Investment Companies

16. Who usually gets the sales charge or load on those funds that have loads?

a. The broker selling the fund

b. The investor buying the fund
c. The investment company
d. The government

Ans: a
Difficulty: Easy
Ref: The Details of Indirect Investing

17. How are no-load funds sold if the salespeople are not paid a sales charge?

a. The brokers sell these funds for no compensation.

b. The investment company sells directly to investors, without using brokers.
c. The investment company sells through banks.
d. Rarely do individual investors buy no-load funds.

Ans: b
Difficulty: Easy
Ref: The Details of Indirect Investing

18. Which of the following is a disadvantage of buying an ETF that tracks an index versus
buying an index mutual fund tracking the same index?

a. Investors can only purchase ETFs at certain times during the day.
b. An investor pays a stockbroker a commission to buy an ETF.
c. An investor cannot use margin or short selling with ETFs.
d. ETFs have higher operating expenses relative to index funds.

Ans: b
Difficulty: Medium
Response: ETF’s have many advantages (trade throughout the day, use of margin, short-selling, low
operating expenses) over index mutual funds; however, the ETF investors will typically incur a
brokerage commission for ETF trades, unlike mutual funds.
Ref: The Details of Indirect Investing

19. Which of the following factors is least important when choosing a mutual fund?

a. The fund’s long-term compound rate of return

b. The tax efficiency of the fund
c. The Morningstar rating for the fund
d. The recommendations of the fund sponsor

Ans: d
Difficulty: Easy
Response: Mutual fund investors should carefully weigh all the relevant facts available on any
given fund; however, a recommendation provided by the fund sponsor itself is likely to be biased.
Ref: The Details of Indirect Investing

20. Which of the following is not an appropriate method to benefit from investing in
international securities?

a. Buying foreign equity open-end mutual funds

b. Buying foreign equity closed-end funds
c. Buying mutual funds that invest in U.S. companies with major foreign business and profits
d. Buying mutual funds that invest in U.S. treasury securities only

Ans: d
Difficulty: Easy
Ref: Investing Internationally through Investment Companies

21. What act requires most investment companies to register with the Securities and Exchange
Commission (SEC)?

a. The Investment Companies Act of 1933

b. The Investment Companies Act of 1940
c. The Investment Company Registration Act of 1933
d. The Securities and Exchange Act of 1940

Ans: b
Difficulty: Medium
Response: The Investment Company Act of 1940 requires most investment companies to register
with the SEC.
Ref: What is an Investment Company?
22. Four distinct types of investment companies are:

a. ETFs, closed-end mutual funds, open-end mutual funds, and REITs

b. ETFs, closed-end mutual funds, open-end mutual funds, and MLPs
c. ETFs, closed-end mutual funds, open-end mutual funds, and index funds
d. ETFs, closed-end mutual funds, open-end mutual funds, and UITs

Answer: d
Difficulty: Medium
Response: ETFs, closed-end and open-end mutual funds, and UITs are four types of investment
companies. Only the first three are discussed in the text because they are the most common.
Ref: What is an Investment Company?

23. Class A shares differ from Class B shares as follows:

a. Class A shares often have front-end sales charges, higher 12b-1 distribution fees, and higher
annual expense fees than Class B shares
b. Class A shares have deferred sales charges, higher 12b-1 distribution fees, and higher annual
expense fees than Class B shares
c. Class A shares have front-end sales charges, lower 12b-1 distribution fees, and lower annual
expense fees than Class B shares
d. Class A shares have deferred sales charges, lower 12b-1 distribution fees, and lower annual
expense fees than Class B shares

Answer: c
Difficulty: Difficult
Response: Class A shares are front-end load sales charge shares, whereas Class B shares are
deferred load sales charge (if held long enough, Class B typically revert to Class A). Class
A shares typically charge lower 12b-1 distribution fees and a lower annual expense fee than
Class B shares.
Ref: The Details of Indirect Investing

Type: True False

1. Investing in mutual funds is considered “indirect” because the investors allow the fund
managers to make investment decisions.

Ans: True
Ref: Three Major Types of Investment Companies

2. Fidelity's Equity-Income Fund is guaranteed by an agency of the U.S. government.

Ans: False
Ref: What is an Investment Company?
3. Money market mutual funds are very safe, but not government guaranteed.

Ans: True
Ref: Three Major Types of Mutual Funds

4. Managers of growth funds invest in companies expected to have strong earnings growth.

Ans: True
Ref: Three Major Types of Mutual Funds

5. The assets in mutual funds have vastly increased since the 1990’s.

Ans: True
Ref: Three Major Types of Investment Companies

6. A closed-end fund has to trade at its net asset value (NAV) because the NAV is the total
value divided by the number of shares.

Ans: False
Ref: The Net Asset Value Per Share

7. Major clients are legally allowed to buy mutual funds at the 4:00 pm NAV, even after
knowing about later events may have changed the price of the underlying securities.

Ans: False
Ref: Ethics in Investing

8. The returns of mutual fund investments are reported by the mutual fund companies and
many news sources.

Ans: True
Ref: The Mechanics of Investing Indirectly

9. The average annual return presented in mutual fund advertising is a simple (arithmetic)
average of the returns earned in each year of the period under review. For example, if a
fund earned 10%, 11%, 12%, 13% and 14% during a five-year period, the average return is
(10+11+12+13+14)/ 5 = 60/5 = 12%

Ans: False
Response: The standard practice is to present the geometric average, which means multiplying the
return relatives for the years together, and then taking the root corresponding to the number of
years. (1.10)*(1.11)*(1.12)*(1.13)*(1.14) = 1.7616. The fifth root of this is 1.1199, a little less
than the 12% calculated as a simple average.
Ref: Investment Company Performance
10. “Survivorship Bias” occurs when the financial press reports performance that ignores funds,
typically poor performing, which were discontinued during the period under review.

Ans: True
Ref: Investment Company Performance