File: ch03 Chapter 3 Indirect Investing

Multiple Choice

1. Which of the following is NOT one of the three types of Investment Companies?
a) stock brokerage companies
b) unit investment trusts
c) closed-end funds
d) mutual funds
Ans: A
EASY
Response: Stock brokerage accounts are used for direct investments.
All three types of investment companies provide indirect investments. Section: Three Major Types
of Investment Companies.

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

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 their assets under management very rapidly in the last 30 years.
Ans: D
EASY
Response Most mutual funds are designed for individual investors, and roughly half of all US
households now own mutual funds. Mutual funds invest in corporate stocks and bonds, as well as
government securities. Section: 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

EASY
Response: Section: 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
HARD
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. Section:
Types of Mutual Funds.

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
EASY
Response: Mutual funds provide daily liquidity, investment diversification and professional
management, but not a guarantee against loss. Section: What is an Investment Company?

6. The text explains that, unlike mutual funds, Unit Investment Trusts are not actively managed.
Why would an investor want to buy an investment that is not managed?
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
MEDIUM

Response: UITs are generally designed to be bought and held, for purposes of capital preservation.
Section: Three Major Types of Investment Companies.

7. ETFs provide all of the following advantages over mutual funds EXCEPT?
a. they 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
HARD
Response: While ETFs have many advantages over mutual fund investing, mutual funds have
clearly been in existence for a much longer period of time. Section: Three Major Types of
Investment Companies.

8. One type of managed investment company is named "closed-end investment companies." What
is it that is "closed?"
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
MEDIUM
Response: The existing shares of the investment company are traded on exchanges: no new shares
are created. Section: Three Major Types of Investment Companies.

9. Which type of investment company is the most popular with smaller investors?
a) Unit investment trusts
b) Closed-end investment companies
c) Open-ended investment companies
d) Exchange-Traded funds
Ans: C
MEDIUM

Response: Unit investment trusts have only $1.5 billion of investors assets, whereas closed-end
funds have $275 billion and ETFs have $250+ billion. By contrast, open-ended funds hold nearly
$12 trillion of assets. Section: Three Major Types of Investment Companies.

10. Which of the following is a major advantage for smaller investors to invest in mutual funds?
a) Mutual funds have a higher return than closed-end funds or Unit Investment Trusts.
b) The small investor can get his 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
EASY
Response: Section: Three Major Types of Investment Companies.

11. Which of the following properly ranks the 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
EASY
Response: Section: Three Major Types of Investment Companies, Figure 3-2.

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
EASY
Response: Section: Three Major Types of Investment Companies, Exhibit 3-1.

13. Which of the following statements concerning index funds is NOT true?
a) The mangers of the fund 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 fund often out-perform actively managed funds.
d) Index funds are managed by the sponsors of the index in question.
Ans: D
EASY
Response: An index fund, by definition, is not actively managed. Section: Types of Mutual Funds.

14. Which of the following is NOT a way to buy shares in open-ended mutual funds?
a) Directly from the fund company.
b) Indirectly, through stock brokers or financial planners.
c) Reinvesting dividends from existing shares.
d) Individuals are not allowed to buy open-ended mutual funds.
Ans: D
EASY
Response: Mutual funds are typically available for purchase from any number of different avenues.
Section: The Mechanics of Investing Indirectly.

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
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 ETFs because of the costs associated with
actively managing versus indexing. Section: 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
EASY
Response: Section: The Mechanics of Investing Indirectly.

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
EASY
Response: Section: The Mechanics of Investing Indirectly.

18. Which of the following is an advantage of buying an index fund, rather than an Exchange
Traded Fund tracking the same index?
a) An investor can buy an ETF at any time as prices move during the market day.
b) An investor pays a stockbroker a commission to buy ETFs.
c) An investor can use margin, or sell short, ETFs.
d) An investor benefits from the lower expenses of ETFs.
Ans: B
MEDIUM
Response: ETFs have many advantages over index mutual funds, however the ETF investors will
typically incur a brokerage commission for ETF trades, unlike mutual funds. Section: The
Mechanics of Investing Indirectly.

19. Which of the following factors is least important when choosing a mutual fund?
a) the compound rate of return over a five or ten year period.
b) the tax efficiency of the fund.
c) the Morningstar rating for the fund.
d) the recommendations of the fund sponsor.
Ans: D

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.
Section: The Mechanics of Investing Indirectly.

20. Which of the following is not an appropriate method to benefit from investing in international
securities?
a) buying foreign equity open-ended mutual funds.
b) buying foreign equity closed-end funds.
c) buying mutual funds that invest in US companies with major foreign business and profits.
d) buying mutual funds that invest in US treasury securities only.
Ans: D
EASY
Response: Section: Investing Internationally through Investment Companies.

True-False

1. Investing in mutual funds is considered indirect because the investors allow the fund
managers to make investment decisions.
Ans: True
Response: Section: Three Major Types of Investment Companies.

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

Ans: False
Response: Section: What is an Investment Company?

3. Money market mutual funds are very safe, but not government guaranteed.
Ans: True
Response: Section: Types of Mutual Funds.

4. Managers of growth funds invest in companies expected to have strong earnings growth.
Ans: True
Response: Section: Types of Mutual Funds.

5. The assets in mutual funds have vastly increased, especially since the 1990s.
Ans: True
Response: Section: Three Major Types of Investment Companies.

6. A closed end fund has to trade at its Net Asset Value, because the NAV is the total value divided
by the number of shares.
Ans: False
Response: Section: 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
Response: Section: Ethics in Investing.

8. The returns of mutual fund investments are reported by the mutual fund companies and many
news sources.
Ans: True
Response: Section: 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
returns for the years together, 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. Section: Investment Company Performance.

10. Survivorship Bias is the tendency for financial press reports to ignore those funds, typically
poor performing, which were discontinued during the period under review.
Ans: True
Response: Section: Investment Company Performance.