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Personal Finance: Turning Money into Wealth, 7e (Keown)

Chapter 14 Mutual Funds: An Easy Way to Diversify


14.1 Why Invest in Mutual Funds?
1) Mutual funds provide an inexpensive way for investors to diversify and gain access to
professional management.
Answer: TRUE
Diff: 1
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
2) Mutual fund shareholders directly own the fund's securities.
Answer: FALSE
Diff: 2
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
3) Mutual funds eliminate the systematic risk through diversification.
Answer: FALSE
Diff: 2
Topic: Risk
AACSB: Diverse and Multicultural Work Environments
4) The trade-off for mutual fund diversification is lower-than-market performance.
Answer: TRUE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
5) Most small investors don't have the time, expertise, or desire to do the research necessary to
invest in individual stocks therefore mutual funds are a good solution.
Answer: TRUE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
6) Mutual funds give smaller investors the same ability to diversify and reduce risk as big
investors with a great deal of money have.
Answer: TRUE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments

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7) One disadvantage of mutual fund investments is that they are illiquid.


Answer: FALSE
Diff: 1
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
8) The potential lower returns on mutual funds versus the potential returns on individual stocks is
due to poor performance by the fund managers.
Answer: FALSE
Diff: 3
Topic: Mutual Fund
AACSB: Information Technology
9) By law, all mutual funds must be broadly diversified.
Answer: FALSE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
10) All mutual funds carry the same level of diversification and exposure to risk.
Answer: FALSE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
11) Because mutual funds trade in such large quantities, they pay far more in terms of
commissions.
Answer: FALSE
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
12) Which of the following is a disadvantage to mutual fund investing?
A) On average they underperform the market returns.
B) Costs may be high and vary dramatically from fund to fund.
C) Not all mutual funds are truly safe.
D) You cannot diversify away systematic risk.
E) All of the above
Answer: E
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments

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13) When you own shares in a mutual fund you make money in which of the following ways?
A) As the value of all of the securities held by the mutual fund increase, the value of each mutual
fund share also increases.
B) If a fund receives interest or dividends from its holdings this income is passed on to share
holders.
C) If the fund sells a security for more than it originally paid for it, the shareholders receive this
in the form of capital gains.
D) You receive a portion of the commissions that the fund manager charges for trades.
E) Only A, B and C are correct.
Answer: E
Diff: 2
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
14) Principle 8 tells us that diversification reduces
A) risk.
B) costs.
C) profitability.
D) earnings.
E) none of the above.
Answer: A
Diff: 1
Topic: Risk
AACSB: Diverse and Multicultural Work Environments
15) For your investment program, you have occasionally been holding a few stocks that you
purchased from various brokers. Based on this, which advantages of mutual funds would be
appealing to you?
A) Diversification
B) Professional management
C) Avoidance of bad brokers
D) only A and C
E) A, B, and C
Answer: E
Diff: 2
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments

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16) Each individual mutual fund hires an investment advisor, generally from the management
company, who oversee the particular fund. How is this advisor paid?
A) Hourly
B) Based on a percentage of the commissions charged on an annual basis
C) Based on a percentage of the total value of the fund on an annual basis
D) Annually based on the capital gains realized by the fund
E) None of the above
Answer: C
Diff: 2
Topic: Mutual Fund
AACSB: Information Technology
17) Which of the following is a benefit to investing in a mutual fund?
A) Most small investors don't have the time, knowledge or desire to do the research necessary to
purchase individual stocks.
B) Mutual fund transaction fees are considerably lower than the brokerage fees most small
investors incur buying and selling individual stocks.
C) Most small investors want to be able to invest relatively small amounts of money on a regular
basis.
D) All of the above are correct.
E) Only A and B are correct.
Answer: D
Diff: 2
Topic: Mutual Fund
AACSB: Information Technology
18) The investor services that most mutual funds offer include
A) bookkeeping services.
B) checking accounts.
C) automatic systems to add to or withdraw from your account.
D) All of the above are correct.
E) All but B are correct
Answer: D
Diff: 1
Topic: Mutual Fund
AACSB: Information Technology
19) Which type of risk can an investor effectively manage by investing in broadly diversified
mutual funds?
A) Serial risk
B) Systematic risk
C) Unsystematic risk
D) None of the above is correct.
Answer: C
Diff: 1
Topic: Risk
AACSB: Diverse and Multicultural Work Environments
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20) Why would someone want to give serious attention to investing in mutual funds? At the same
time, why would you not invest in them?
Answer: Mutual funds on the whole serve to level the investment playing field between large
and small investors. They offer an inexpensive way to instant diversification, professional
management guidance, minimal transaction costs, liquidity, flexibility, many services, avoidance
of bad brokers.
Mutual funds perform lower than the market does. Sales and annual expense fees can be very
costly be selective. Not all mutual funds are truly safe. Systematic risk is still present and
taxes are not deferred.
Diff: 2
Topic: Mutual Fund
AACSB: Reflective Thinking
21) What are the two broad types of risks that are associated with investing? Can you avoid them
by investing in Mutual Funds?
Answer: The two broad types of risks associated with investing are systemic and unsystemic
risks. A broadly diversified Mutual Fund can protect you from unsystemic risk associated with an
individual company, industry or country. These funds invest in a broad spectrum of firms,
industries and possibly countries to minimize the impact of specific unsystemic risks.
A narrowly focused sector fund invests in many firms in the same industry or country. While the
risk of a few firms failing is diversified away, the risk of a systemic event effecting the entire
industry or country is not diversified away. A new technology, political change, natural disaster
or some other broad impact will effect all the investments in the fund.
Diff: 3
Topic: Risk
AACSB: Reflective Thinking
22) Do the advantages of investing in a Mutual Fund outweigh the disadvantages for the average
small investor?
Answer: A case can be made that the advantages to the small investor far outweigh the
disadvantages of investing in mutual funds. The average investor does not have the time,
expertise or desire to do the research necessary to invest in individual stocks. They typically
don't have the money to adequately diversify at realistic costs. They are fairly naive when it
comes to market trends, predatory Brokers, and economic impacts on the markets. Mutual Fund
Managers are much better suited to succeed in the markets than an individual investor. The
services funds provide are invaluable with record keeping and paying taxes. The trick is to find a
good Mutual Fund company that provides the selection and services that you need and dollar
cost average your investments.
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments

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23) Briefly explain the three ways to make money when you own shares in a mutual fund.
Answer: First, as the value of all the securities held by the mutual fund increases, the value of
each mutual fund share also goes up.
Second, if a fund receives interest or dividends from its holdings, this revenue is passed on to
shareholders in the form of dividends.
Third, if the fund sells a security for more than it originally paid for the security, the shareholders
receive this gain in the form of a capital gains distribution, generally paid annually.
Diff: 3
Topic: Mutual Fund
AACSB: Reflective Thinking
14.2 Investment Companies
1) At the beginning of 2014, bond fundsincluding both municipal and taxable bond fundsmade
up the largest segment of the $279 billion closed-end fund market.
Answer: TRUE
Diff: 3
Topic: Bond Fund
AACSB: Analytical Thinking
2) An equity REIT investment is limited to mortgages on income producing properties.
Answer: FALSE
Diff: 3
Topic: REIT
AACSB: Information Technology
3) A unit investment trust is a fixed pool of securities, generally municipal bonds, with each unit
representing a proportionate ownership in that pool.
Answer: TRUE
Diff: 2
Topic: Unit Investment Trust
AACSB: Information Technology
4) Shares in open-end mutual funds are actively traded in secondary markets.
Answer: FALSE
Diff: 2
Topic: Mutual Fund
AACSB: Information Technology
5) An open-end mutual fund has a fixed number of shares which are sold by the mutual fund at
its inception.
Answer: FALSE
Diff: 2
Topic: Mutual Fund
AACSB: Information Technology

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6) When you own shares in a mutual fund, you directly own shares of the companies that make
up the fund.
Answer: FALSE
Diff: 2
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
7) The most common and popular form of mutual fund is an open-end mutual fund.
Answer: TRUE
Diff: 2
Topic: Mutual Fund
AACSB: Information Technology
8) The term "open end" mutual fund means that this type of investment company can issue an
unlimited number of ownership shares.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Information Technology
9) A closed-end fund trades more like common stock than a mutual fund.
Answer: TRUE
Diff: 3
Topic: Mutual Fund
AACSB: Information Technology
10) A unit investment trust usually invests in ________ and an REIT always invests in
________.
A) real estate; agency bonds
B) real estate; municipal bonds
C) real estate; load mutual funds
D) municipal bonds; real estate
E) municipal bonds; real estate bonds
Answer: D
Diff: 2
Topic: Unit Investment Trust
AACSB: Information Technology

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11) A(n) ________ is a fixed pool of securities, generally municipal bonds, with each unit
representing a proportionate ownership in that pool.
A) open-end investment company
B) closed-end mutual fund
C) unit investment trust
D) real estate investment trust
Answer: C
Diff: 1
Topic: Mutual Fund
AACSB: Information Technology
12) A(n) ________ is a mutual fund company that has the ability to issue as many shares as
investors are willing to purchase.
A) closed-end mutual fund
B) share repurchase fund
C) open-end mutual fund
D) variable share mutual fund
E) none of the above
Answer: C
Diff: 1
Topic: Mutual Fund
AACSB: Information Technology
13) An ________ is a fixed pool of securities, generally municipal bonds.
A) earning trust
B) unit investment trust
C) equity corporation
D) asset diversification company
E) none of the above
Answer: B
Diff: 1
Topic: Mutual Fund
AACSB: Information Technology
14) Roberta Cartwright puts money each month into a mutual fund that has very few controls; in
that, the managers can invest in whatever they want because this type of fund is not regulated by
the SEC. Roberta has a(n) ________ fund.
A) open-end
B) closed-end
C) hedge
D) no-load
E) back-end load
Answer: C
Diff: 1
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
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15) Hedge fund managers charge very high fees, generally taking ________ of the assets under
management (even when the fund loses money) along with ________ of the profitsand some
take even more.
A) 1 percent; 10 percent
B) 2 percent; 10 percent
C) 2 percent; 20 percent
D) 5 percent; 25 percent
Answer: B
Diff: 3
Topic: Mutual Fund
AACSB: Reflective Thinking
16) Former hedge fund manager Bernie Madoff ran a Ponzi scheme, in which he took money
from new investors and used that money to pay earlier investors, all the while pocketing most of
the money for himself. In the end, Madoff lost around ________ of his investors' money and
ended up behind bars."
A) $100 million
B) $5 billion
C) $25 billion
D) $50 billion
Answer: D
Diff: 3
Topic: Mutual Fund
AACSB: Reflective Thinking
17) Which of the following funds would be the most appropriate investment for the average
small investor?
A) No-load open-end fund
B) No-load closed-end fund
C) Front-end load fund
D) Back-end load fund
Answer: A
Diff: 2
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
18) Compare and contrast open-end and closed-end mutual funds.
Answer: Open-end funds can literally issue as many shares as investors want. The fund grows
and shrinks as shares are bought by investors and sold by the same. The value of all the
investments determines how much each share in the fund is worth. On the other hand, a closedend fund only sells shares once. After that, investors must conduct trading among themselves.
This fund determines the value of each share by the value of the investments that the fund holds
and investors' demand for the shares in the fund.
Diff: 1
Topic: Mutual Fund
AACSB: Analytical Thinking
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19) In what ways do unit investment trusts and real estate investment trusts resemble mutual
funds?
Answer: UITs are a pool of investments, generally municipal bonds, and REITs are also a pool
of investments, in this case made up of a diversity of real estate holdings. Investors buy shares
just as they do in mutual funds. Like mutual funds, these two investments are not limited only to
the wealthy.
Diff: 2
Topic: Unit Investment Trust
AACSB: Analytical Thinking
14.3 Calculating Mutual Fund Costs and Returns
1) 12b-1 fees are marketing expenses for the mutual fund that are passed on to the fund
shareholders.
Answer: TRUE
Diff: 1
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
2) A mutual fund that does not charge a commission on your ownership shares is referred to as a
load fund.
Answer: FALSE
Diff: 1
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
3) "Classes" of mutual funds have different fee arrangements attached to them.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
4) Sometimes, when you purchase shares directly from the mutual fund company itself, there
will not be a sales load.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
5) Mutual funds charge high sales loads because their potential returns are much higher than the
returns for individual stocks.
Answer: FALSE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology

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6) Back-end load mutual funds charge a commission when the investor sells the mutual fund.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
7) Mutual fund fees and expenses will negatively affect the return you receive on your
investment.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
8) A mutual fund's expense ratio compares the fund's expenses to its total assets.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
9) Net asset value is determined by taking the total market value of all the securities held by the
mutual fund, subtracting out any liabilities, and dividing the result by the number of shares
outstanding.
Answer: TRUE
Diff: 1
Topic: Net Asset Value
AACSB: Analytical Thinking
10) All distributions from a mutual fund, whether paid out or reinvested, are taxable in the year
in which they occur.
Answer: TRUE
Diff: 1
Topic: Mutual Fund Returns
AACSB: Diverse and Multicultural Work Environments
11) When you own shares of a mutual fund, you can choose to have the dividend and capital
gains distributions paid directly to you in the form of cash or you can choose to have them
reinvested into additional shares of the fund itself.
Answer: TRUE
Diff: 1
Topic: Mutual Fund Returns
AACSB: Information Technology

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12) Which of the following statements is true regarding mutual fund load charges?
A) Load funds perform better than no-load funds.
B) Back-end load funds perform better than no-load funds.
C) Load funds perform more poorly than back-end load funds.
D) No-load funds perform just as well as load funds.
E) None of the above
Answer: D
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Analytical Thinking
13) Tabitha is just beginning to develop her financial portfolio. She does not want to pay
commissions to purchase shares in mutual funds, as her friend you would advise her to invest her
dollars in ________ funds.
A) load
B) front-load
C) back-load
D) no-load
E) side-load
Answer: D
Diff: 1
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
14) A mutual fund that does not charge a commission to own its shares is called a
A) free issue fund.
B) market fund.
C) no-load fund.
D) no-charge fund.
E) free-load fund.
Answer: C
Diff: 1
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
15) When comparing which mutual fund to invest in, which of the following would be important
to consider?
A) Load
B) Net asset value
C) Expense ratio
D) All of the above are correct.
E) Only A and C are correct.
Answer: D
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
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16) Which of the following are passed on to fund share holders through 12b-1 fees?
A) Commissions
B) Advertising expenses
C) Promotional fees
D) Only B and C
E) All of the above
Answer: D
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Information Technology
17) Which of the following will affect your capital gains liability?
A) Turnover ratio
B) Changes in net asset value
C) Expense ratio
D) All of the above are correct.
E) Only A and B are correct.
Answer: E
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Diverse and Multicultural Work Environments
18) The ________ is the value of the mutual fund's holdings, minus any debt, divided by the
number of shares outstanding.
A) net worth
B) market value
C) tangible value
D) net asset value
E) none of the above
Answer: D
Diff: 1
Topic: Net Asset Value
AACSB: Analytical Thinking
19) Total returns on mutual funds can be calculated by adding dividends distributed, capital gains
distributed, and ________ and dividing this sum by the beginning NAV.
A) beginning NAV - ending NAV
B) ending NAV - beginning NAV
C) dividends undistributed + capital gains undistributed
D) beginning NAV + ending NAV
E) ending NAV + beginning NAV
Answer: B
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking

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20) What is the total return for a mutual fund with the following characteristics?
beginning NAV
= $55.82
ending NAV
= $70.52
dividends distributed
= $2.25
capital gains distributed
= $3.50
A) 29.71%
B) 30.82%
C) 32.26%
D) 36.64%
Answer: D
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
21) Zippo Mutual Fund is one of your best performers. It just announced a year-end distribution
of $2.50 per share in capital gains and $4.25 in dividends. Assuming the NAV increased from
$31.50 to $43.75, calculate your total annual return.
A) 60.32%
B) 46.87%
C) 26.95%
D) 24.53%
Answer: A
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
22) You purchased 100 shares of Gibraltar Strength Fund for $20.50 per share. As a result of
distribution reinvestment you currently own 120 shares with a NAV of $22.75 per share. What is
your total return?
A) 16.67%
B) 20.00%
C) 24.91%
D) 33.17%
Answer: D
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking

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23) Suppose that the current value of all of a mutual fund's holdings is determined to be $750
million. The fund's liabilities are $125 million and it grew at 20% from last year. It currently has
45 million shares outstanding. What is the fund's NAV?
A) $12.00 per share
B) $13.89 per share
C) $14.40 per share
D) $16.80 per share
Answer: B
Diff: 3
Topic: Net Asset Value
AACSB: Analytical Thinking
24) You purchased 100 shares of a fund for $15.50 per share. Its current NAV is 20.75 per share.
There were no distributions. What is your total return?
A) 33.87%
B) 22.33%
C) 79.67%
D) 25.51%
Answer: A
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
25) You purchased 100 shares of Gibraltar Strength Fund for $12.75 per share. Its current NAV is
18.75 per share. There was a total of $0.25 in dividends and $0.75 in capital gains distributed.
What is your total return?
A) 32.00%
B) 37.33%
C) 47.06%
D) 54.90%
Answer: D
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
26) What does the following mathematical expression yield? (total market value of all securities
- liabilities) divided by (total shares outstanding) =
A) asset value.
B) net value.
C) net asset value.
D) net return value.
E) asset return value.
Answer: C
Diff: 2
Topic: Net Asset Value
AACSB: Analytical Thinking
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27) You purchased 1,000 shares of fund ABC for $35.00 NAV per share. You elected the
dividend reinvestment plan and had all dividend and capital gains distributions reinvested in
additional shares. You just closed your account and sold 1,100 shares for $30 NAV. What was
your total return on this investment?
A) -6.06%
B) -5.71%
C) 5.71%
D) 6.06%
Answer: B
Diff: 2
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
28) You purchased 500 shares in a mutual fund for $32 NAV. You elected the dividend
reinvestment plan and had all dividend and capital gains distributions reinvested in additional
shares. You just closed your account and sold 550 shares for $48 NAV. What was your total
return on this investment?
A) 24.03%
B) 34.29%
C) 50.86%
D) 65.00%
Answer: D
Diff: 3
Topic: Mutual Fund Returns
AACSB: Analytical Thinking
29) Explain what the three 'classes' of a mutual fund shares are all about.
Answer: There is actually only one mutual fund but you can purchase shares in this fund several
different ways. Depending on how you purchase the share, there may be different loads or sales
commissions associated with the purchase or redemption of the share. Class A shares can be
purchased directly from the Fund itself or through an Agent like a Financial planner. Class A
shares have a front-end load or commission that comes right off the top of your purchase. Class
B shares are typically sold by a Stock Broker. They do not have a front-end load so your entire
investment is placed into your account. If you withdraw money before a certain date, then there
is a back-end load applied to your withdrawal. Class C funds are the least attractive since they
have both a front-end and back-end load plus higher fees.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments

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30) Explain how sales loads and fund expenses can negatively impact your return on investment
in a mutual fund.
Answer: The sales load and fund expenses are subtracted out of your account which means you
have less of your money available or fewer shares available to grow and earn a return. For
example, if you invest $1,000 into a 5% front-end load fund, $50 is subtracted off the top leaving
only $950 in the account. If your account grows to $1,500 by the end of the year, and the fund
expenses are 2%, then they will remove another $30 from your account balance. With this
example, if the total gross return on your money was 12%, after the load and expenses your net
return would be much less.
Diff: 3
Topic: Mutual Fund Cost and Fees
AACSB: Diverse and Multicultural Work Environments
31) Briefly describe the cost involved in mutual funds.
Answer: A mutual fund has either a sales commission or no sales commission involved. Funds
are either a no-load fund, a load fund, or a back-end load, the load being the commission. A
mutual fund can also charge management, marketing, and trading fees.
Diff: 1
Topic: Fees
AACSB: Information Technology
32) Explain how a dividend reinvestment plan is similar to compounding and the time value of
money.
Answer: With compounding, the interest you earned from previous periods earns interest in the
current period. As time progresses, the interest earning interest becomes a substantial part of your
future value. By reinvesting all dividend and capital gains distributions into additional shares of
the fund, you are basically compounding these new shares which will earn more distributions,
additional new shares, and this reinvesting will make up a substantial portion of the future value
of your total investment.
Diff: 2
Topic: Mutual Fund Returns
AACSB: Reflective Thinking
33) What are the tax liabilities concerning investing in a mutual fund?
Answer: There may be a tax liability due on the current dividend and capital gains distributions
made during the current tax year. Taxes on these distributions are due regardless if you received
the distributions in cash or reinvested them in additional shares. In addition to taxes on
distributions, there is also a potential capital gains tax on the increase in NAV from the purchase
to the sale. One of the great benefits of investing in most large Mutual Fund Companies is they
provide shareholders with an end of the year 1099 tax statement that shows all distributions and
capital gains for the previous tax year.
Diff: 3
Topic: Mutual Fund Returns
AACSB: Diverse and Multicultural Work Environments

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14.4 Types and Objectives of Mutual Funds


1) Exchange traded funds are mutual funds that trade on an exchange just like individual
securities and can be bought or sold throughout the trading day.
Answer: TRUE
Diff: 1
Topic: Exchange Traded Fund
AACSB: Diverse and Multicultural Work Environments
2) A sector fund is a mutual fund that tries to maximize the degree of diversification.
Answer: FALSE
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
3) Tax-exempt money market mutual funds invest in only very short-term municipal debt.
Answer: TRUE
Diff: 1
Topic: Money Market Mutual Fund
AACSB: Diverse and Multicultural Work Environments
4) Money market mutual funds invest primarily in the stocks of publicly traded companies.
Answer: FALSE
Diff: 2
Topic: Money Market Mutual Fund
AACSB: Diverse and Multicultural Work Environments
5) Sixty-five percent of Sally's mutual funds are invested in environmentally friendly companies.
We can assume Sally has invested in sector funds.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
6) Stock market mutual funds are not very popular and consumers tend to invest in them the
least.
Answer: FALSE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
7) A bond mutual fund is an appropriate choice for an investor with an income goal.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
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8) An aggressive growth fund is an appropriate choice for an investor looking for capital gains.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
9) Brian and Kallie are looking for investments that provide steady income to live on, moderate
growth in capital, and moderate stability in their investments. They should look into balanced
mutual funds.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
10) An index fund is a great choice for those who want to "beat the market."
Answer: FALSE
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
11) For an investor with little time or desire to follow the markets, a life cycle fund would be an
appropriate choice for their retirement savings.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
12) By law, a bond fund may not invest in international securities.
Answer: FALSE
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
13) An ETF provides better diversification than investing in individual company stocks.
Answer: TRUE
Diff: 2
Topic: Exchange Traded Fund
AACSB: Diverse and Multicultural Work Environments
14) With target retirement funds the only decision you have to make is when you plan to retire.
Answer: TRUE
Diff: 3
Topic: Mutual Funds
AACSB: Diverse and Multicultural Work Environments

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15) An ETF provides similar services to an investor to those that a mutual fund investment
provides.
Answer: FALSE
Diff: 3
Topic: Exchange Traded Fund
AACSB: Diverse and Multicultural Work Environments
16) One of the most valuable mutual fund services available is automatic reinvestment of cash
flows.
Answer: TRUE
Diff: 3
Topic: Mutual Fund Services
AACSB: Information Technology
17) Once you open a mutual fund account, you can use EFT to have money directly withdrawn
from your bank account to pay yourself first.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Services
AACSB: Information Technology
18) Money market mutual funds have check writing privileges.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Services
AACSB: Information Technology
19) According to the Keown book, ________ are by far the most popular funds, accounting for
more than half of all mutual funds.
A) equity funds
B) bond funds
C) hybrid funds
D) money market funds
Answer: A
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Reflective Thinking

20
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20) One type of mutual fund does not endeavor to achieve the goals of a balance of bonds and
stock or growth, income, and stability. Instead, it focuses on personal characteristics, such as age
and risk tolerance, and your position in the financial life cycle. This is the
A) index fund.
B) sector fund.
C) growth and income fund.
D) balanced fund.
E) life cycle fund.
Answer: E
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
21) Money market mutual funds
A) are very risky investments.
B) require significant investments, so are out of reach of the common investor.
C) carry no loads.
D) None of the above.
E) Both A and B are correct.
Answer: C
Diff: 2
Topic: Money Market Mutual Fund
AACSB: Analytical Thinking
22) Bonnie and James are retired. They wish to continue to invest in their portfolio and are
seeking income instead of growth. Which should they invest in?
A) Growth funds
B) Bond funds
C) Sector funds
D) All of the above are correct.
E) Only A and C are correct.
Answer: B
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
23) Of the different types of mutual funds, ________ are by far the most popular, and now
account for half of all mutual funds.
A) money market mutual funds
B) stock mutual funds
C) balanced mutual funds
D) asset allocation funds
E) bond funds
Answer: B
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
21
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24) If you want to invest only in the telecommunications industry, which fund would be
appropriate for you?
A) S&P 500 Index fund
B) Telecommunications sector fund
C) Telecommunications ETF
D) Telecommunications money market fund
E) Both B and C are correct.
Answer: E
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Information Technology
25) Life cycle funds
A) are designed for people with at least 20 years until retirement.
B) require you to decide how to allocate your investment among stocks, bonds, and money
market instruments.
C) grow less conservative as your retirement date nears.
D) try to tailor their holding to the investor's individual age, and risk tolerance.
Answer: D
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
26) A balanced mutual fund is aimed at investors who want
A) steady income to live on.
B) moderate growth in capital.
C) moderate stability in their investments.
D) all of the above.
E) none of the above.
Answer: D
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
27) Which of the following funds protect you from systematic risk?
A) S&P 500 Index fund
B) Growth fund
C) Balanced fund
D) All of the above
E) None of the above
Answer: E
Diff: 3
Topic: Risk
AACSB: Diverse and Multicultural Work Environments

22
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28) What are the differences between an ETF and a mutual fund?
A) An ETF can be traded like a share of common stock.
B) An ETF can be purchased on margin or sold short like a share of common stock.
C) An ETF is more tax-efficient than most mutual funds.
D) All of the above are correct.
E) Only A and C are correct.
Answer: D
Diff: 3
Topic: Exchange Traded Fund
AACSB: Analytical Thinking
29) Which of the following services do ETFs offer?
A) Automatic reinvestment of dividends, interest, and capital gains
B) Bookkeeping and tax help
C) Phone and Internet switching
D) All of the above
E) None of the above
Answer: E
Diff: 3
Topic: Exchange Traded Fund
AACSB: Diverse and Multicultural Work Environments
30) One of the advantages of municipal bond funds is that
A) they may be exempt from state taxes.
B) the interest is generally exempt from federal taxes.
C) they are all no-load funds.
D) both A and B are correct.
Answer: D
Diff: 3
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
31) For an investor with some speculative money to invest, which fund would be an appropriate
choice for potentially large returns?
A) Junk bond fund
B) Aggressive growth fund
C) High technology sector fund
D) All of the above are correct.
E) Only A and C are correct.
Answer: D
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments

23
Copyright 2016 Pearson Education, Inc.

32) Bond funds differ from individual bond purchases in that


A) bond funds offer less liquidity than individual bonds.
B) with a bond fund, you don't get professional management.
C) the bond fund doesn't mature as individual bonds do.
D) all of the above.
Answer: C
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
33) Donel is investing in a mutual fund that really is not as diversified as other funds. It may
enjoy good capital gains but is also much riskier when it comes to unsystematic risk. This fund is
called a(n) ________ fund.
A) growth-and-income
B) sector
C) life cycle
D) asset allocation
E) bond
Answer: B
Diff: 3
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
34) The mutual fund that invests in Treasury bills and very short-term notes and is considered
practically risk free is the
A) stock fund.
B) bond fund.
C) balanced fund.
D) life cycle fund.
E) money market fund.
Answer: E
Diff: 1
Topic: Money Market Mutual Fund
AACSB: Diverse and Multicultural Work Environments
35) Which of the following mutual fund services is similar in concept to compounding and the
time value of money?
A) Dollar cost averaging
B) Automatic reinvestment
C) Funds express options
D) Internet switching
Answer: B
Diff: 2
Topic: Mutual Fund Services
AACSB: Analytical Thinking

24
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36) Why are stock mutual funds so popular? Briefly outline the highlights of each type of fund.
Answer: There is a stock mutual fund for almost every need about 6,000 in all. They serve
many purposes as follows:
1. Aggressive growth funds try to maximize capital appreciation while ignoring income; they
are risky with wide price swings.
2. Small-company growth funds are aggressive funds in undiscovered companies with
potentially unlimited future growth.
3. Growth funds are similar to aggressive funds but pay more attention to strong firms that pay
dividends.
4. Growth-and-income funds attempt to provide a steady stream of income and have some
potential for increasing value.
5. Sector funds try to capture the advantage of a single industry; they are risky and lose the
diversity advantage.
6. Index funds buy stocks that make up the S&P 500, which is good for those who want to
mimic the market rather than beat it at low cost.
7. International funds seek to diversify and grow by focusing on general world regions or
foreign companies with abnormal growth potential regardless of location.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Reflective Thinking
37) There are dissimilarities between U.S. government, GNMA, municipal, and corporate bond
funds. Please point them out.
Answer: The major difference stems from the bond vehicle. U.S. government bonds invest in
securities issued by the federal government. GNMA bonds specialize in pools of residential
mortgages. Municipal funds are generally exempt from some form of taxes and invest in
municipalities, such as cities, counties, and states. Corporate funds invest in various for-profit
corporations and have the potential for defaulting.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
38) Compare the investment vehicles and tax treatment of tax-exempt and government securities
money market mutual funds.
Answer: The tax-exempt fund invests only in very short-term municipal debt, while the
government securities fund invests solely in U.S. government securities. The former is exempt
from federal income taxes, while the latter is not.
Diff: 2
Topic: Money Market Mutual Fund
AACSB: Diverse and Multicultural Work Environments
39) How is an asset allocation fund different from a balanced mutual fund?
Answer: Asset allocation funds seek to time the market by moving money between stocks and
bonds. These attempts may cost more and therefore diminish returns.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Diverse and Multicultural Work Environments
25
Copyright 2016 Pearson Education, Inc.

40) Prepare a case for investing in a bond fund versus individual bonds.
Answer: A bond mutual fund suits the small investor as well as the large investor. You can begin
with as little as $1,000 and add more later in smaller amounts. The funds offer more liquidity
than individual bonds, and on top of that you get professional management. Rather than
receiving a semiannual check as with bonds, you can choose a monthly check or reinvest back
into the fund. The bond fund does not mature; it is virtually perpetual and carefree.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Information Technology
41) What is the purpose of a Target Retirement fund and who would benefit from it?
Answer: A target retirement fund is designed to make sure that an individual is properly
diversified based on how much longer they have until retirement. A younger person's fund would
have a greater percentage of common stocks verses bonds because they have enough time
remaining to be exposed to more risk. As a person nears retirement age, the fund's managers
automatically change the make-up of the investments in the fund to more conservative, less
volatile investments more appropriate for someone needing their money fairly soon.
These types of funds are ideal for the average person who does not have the time, expertise or
desire to put in the effort necessary to manage their own monies. With these funds, a person just
states what year they plan on retiring and then set up automatic payments and everything else is
decided by professional investment managers.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Analytical Thinking
42) What are the advantages of index funds?
Answer: Index funds are set up to mimic or duplicate the stocks found in a market index like the
S&P 500 or or Dow Jones Industrials. They are called passively managed funds because it does
not take any expertise to select the stocks from the index, these funds do not require high paid
managers or have a lot of trading costs or other expenses associated with a actively traded fund.
Because of the low costs, most index funds are no-load funds with very low expense fees.
Because of the efficient markets, it is very difficult for an actively traded fund to consistently
beat the market indexes over time. For a typical, dollar cost averaging, buy and hold investor, the
index funds are a very good choice for their important savings.
Diff: 2
Topic: Mutual Fund Classifications
AACSB: Analytical Thinking

26
Copyright 2016 Pearson Education, Inc.

43) What are ETFs and what are their advantages?


Answer: An ETF is a hybrid type investment that mimics the diversification of a mutual fund
but enjoys the flexibility of an actively traded share of common stock. Most ETFs follow an
underlying index, similar to an index fund. The main advantages of an ETF is that you don't need
to open up a special account or have a minimum deposit for an account. If you already have a
trading account you can purchase shares of an ETF just like shares of any common stock. You
can actively trade the ETF anytime of the day taking advantages of market movements. You can
trade ETFs using margin and short selling. Because of their nature, the tax liability for capital
gains comes upon the trade only and is much less complex than the potential tax liability of
mutual funds.
Diff: 2
Topic: Exchange Traded Fund
AACSB: Analytical Thinking
14.5 Buying a Mutual Fund
1) The process of buying a mutual fund involves determining your investment goals, identifying
funds that meet your objectives, and evaluating those funds.
Answer: TRUE
Diff: 1
Topic: Financial Goals
AACSB: Reflective Thinking
2) To obtain information about mutual funds you must always pay a fee.
Answer: FALSE
Diff: 1
Topic: Sources of Information
AACSB: Information Technology
3) Mutual funds sold by a bank are insured by the federal government.
Answer: FALSE
Diff: 1
Topic: Mutual Fund
AACSB: Diverse and Multicultural Work Environments
4) When screening mutual funds,two of the best websites are: Morningstar and Yahoo!Finance.
Answer: TRUE
Diff: 3
Topic: Sources of Information
AACSB: Information Technology
5) A source of third-party information like Morningstar or Yahoo! Finance is typically biased
towards certain mutual fund companies.
Answer: FALSE
Diff: 3
Topic: Sources of Information
AACSB: Information Technology
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6) When selecting a mutual fund, since past performance doesn't necessarily predict future
results, you don't need to look at the fund's past performance.
Answer: FALSE
Diff: 3
Topic: Sources of Information
AACSB: Analytical Thinking
7) You may be charged a small transaction fee when you buy no load funds through a "mutual
fund supermarket."
Answer: TRUE
Diff: 2
Topic: Sources of Information
AACSB: Information Technology
8) The No. 1 predictor of mutual fund performance is "looking at the mutual fund's costs"; the
lower they are, the better the predicted performance.
Answer: TRUE
Diff: 2
Topic: Mutual Fund Cost and Fees
AACSB: Analytical Thinking
9) Bernie has followed the three steps to begin mutual fund investing and is ready to make the
purchase. What are his choices in buying?
A) Use a broker.
B) Use a financial advisor.
C) Buy direct.
D) Buy through a mutual fund supermarket.
E) All of the above
Answer: E
Diff: 2
Topic: Sources of Information
AACSB: Information Technology
10) Why is it important to determine what investment goals you are trying to achieve before you
invest in a mutual fund?
A) The mutual fund company may attempt to change your goals to meet their fund offerings.
B) You must provide the mutual fund company with your defined goals before they allow you to
purchase shares.
C) You must look for a mutual fund with the same or similar investment goals that you have in
order to find an appropriate fund.
D) All of the above are correct.
E) Only A and B are correct.
Answer: C
Diff: 2
Topic: Financial Goals
AACSB: Reflective Thinking
28
Copyright 2016 Pearson Education, Inc.

11) What sources of information does Art Keown, your textbook author, recommend when
researching mutual fund investing?
A) Yahoo! Finance
B) The Wall Street Journal
C) MoneyCentral
D) Morningstar Mutual Funds
E) All of the above
Answer: E
Diff: 3
Topic: Sources of Information
AACSB: Reflective Thinking
12) A mutual fund ________ provides a description of the mutual fund including the fund's
objectives and risk, its historical performance, its expenses, manager's history and other
information.
A) prospectus
B) prospector
C) debenture
D) indenture
Answer: A
Diff: 2
Topic: Sources of Information
AACSB: Information Technology
13) What information can an investor find in the prospectus of a mutual fund?
A) The fund's goal and investment strategy
B) The fund manager's past experience
C) The fund's 12b-1 fees
D) All of the above are correct.
E) Only A and B are correct.
Answer: D
Diff: 3
Topic: Sources of Information
AACSB: Information Technology
14) Investment companies are required by law to offer a prospectus to prospective investors. Let
your instructor know which 5 parts you think are the most important and why.
Answer: The fund's goal and investment strategy is important because I want it to align with my
own personal goal and strategy. The fund's manager must have a good track record of successful
performance or I will not invest. I must know what the distribution options are to see if they will
meet my needs. I want to take advantage of all of the services offered to get the most out of my
mutual fund. Last, I want to know the fund's performance since inception. Let's face it, if it hasn't
done well I don't need it.
Diff: 2
Topic: Prospectus
AACSB: Analytical Thinking
29
Copyright 2016 Pearson Education, Inc.

15) What are the four choices for purchasing a mutual fund?
Answer:
1. broker
2. financial advisor
3. buy direct
4. mutual fund supermarket
Diff: 1
Topic: Sources of Information
AACSB: Analytical Thinking
16) Provide a list of sources of information to evaluate mutual funds.
Answer:
1. Morningstar Mutual Funds
2. The Wall Street Journal
3. Yahoo! Finance
4. MoneyCentral
5. The Mutual Fund Prospectus
Diff: 1
Topic: Sources of Information
AACSB: Information Technology
17) What steps would you advise someone to go through when buying a mutual fund?
Answer: First, determine your investment goals. Second, identify funds that meet your
objectives. Third, evaluate the fund.
Diff: 2
Topic: Mutual Fund
AACSB: Analytical Thinking

30
Copyright 2016 Pearson Education, Inc.

18) According to the Keown book, mutual funds are a great way to invest. Once you have the
minimum amount savedabout $3,000 for most Vanguard mutual fundsit's time to start
investing. What are a few factors to keep in mind?
Answer: Goals. Set up your investment plan to meet your goals.
Put your plan on autopilot. The easiest way to save is to never see the money in the first place.
Just about every mutual fund allows you to have money automatically pulled from your checking
account each month and invested in the mutual fund of your choice. Paying yourself first, as it's
called, always makes sense.
Taxes. As you invest, keep your tax situation in mind, because mutual funds pass along taxable
income from their investments in the form of dividends and capital gainsand even if your
money remains invested in the mutual funds, there might be taxes to pay.
Taxes when you move money. When you move money from one fund to another, even within
the same fund family, the IRS looks at the movement as a sale and a purchase and assesses taxes
on any gain from the sale.
The losers. While it's hard to pick winners, it's much easier to pick losers. If a fund has done
poorly in the past, chances are it will do poorly in the future. Take the time to check out the past
performance of a fund you are interested in.
Costs, costs, costs. Keep your costs down, as lower-cost mutual funds tend to do better than
higher-cost funds. Read the fine print. Watch for commissions, maintenance, and other fees that
eat away at your money!
Diff: 3
Topic: Mutual Funds
AACSB: Analytical Thinking

31
Copyright 2016 Pearson Education, Inc.