Gitman Chapter 12

Chapter 12
Mutual Funds: Professionally Managed Portfolios
12.1 Learning Goal 1
1) Mutual funds provide a simplified means of diversifying a portfolio.
Answer: TRUE
Question Status: Previous Edition
2) When an investor buys shares in a mutual fund, he or she becomes a part owner of a portfolio of
securities.
Answer: TRUE
3) Mutual funds rank second only to banks as being the largest financial intermediary in the United
States.
Answer: FALSE
4) The transfer agent for a mutual fund physically safeguards the securities being bought and sold by
that firm.
Answer: FALSE
5) Mutual funds tend to outperform the market.
Answer: FALSE
6) For a mutual fund to avoid taxation it must distribute at least 90% of its realized capital gains and
investment income.
Answer: FALSE
7) Which one of the following statements concerning mutual funds is correct?
A) The selection of individual securities remains with the mutual fund investor.
B) Mutual funds were first created in the 1980s.
C) The mutual fund industry is the largest financial intermediary in the United States.
D) Mutual funds are generally highly concentrated portfolios.
Answer: C
Chapter 12 Professionally Managed Portfolios 213
8) Which of the following are advantages offered by mutual funds?
I. professional portfolio management
II. dividend reinvestment
III. consistent returns in excess of the overall market rate of return
IV. modest capital outlay for investors
A) I and II only
B) I and IV only
C) II, III and IV only
D) I, II and IV only
Answer: D
9) One drawback of investing in mutual funds is the
A) annual management fee.
B) lack of liquidity of fund shares.
C) amount required for the initial investment.
D) lack of information on the performance of the fund.
Answer: A
10) Which one of the following statements is correct concerning players in the mutual fund industry?
A) Security analysts and traders work for the management company.
B) Normally a bank serves as the custodian.
C) The management company maintains the shareholder records.
D) The mutual fund shareholders are the owners of the management company.
Answer: B
11) The Securities Act of 1933
A) set forth the antifraud provisions to which mutual funds are subject.
B) regulates investment advisers.
C) requires mutual funds to provide a prospectus to each prospective investor.
D) sets forth the qualification requirements for classification as an investment company.
Answer: C
214 Gitman/Joehnk · Fundamentals of Investing, Tenth Edition
12) The Investment Company Act of 1940 established the
A) maximum number of shares that can be issued by an open-end fund.
B) standards for the income distributions and fee structures of mutual funds.
C) guidelines under which a prospectus must be prepared and delivered.
D) investment objectives under which an individual mutual fund must operate.
Answer: B
13) To operate as a regulated investment company and enjoy the related tax benefits, a mutual fund
must annually distribute to its shareholders
A) half of its realized capital gains, and interest and dividend income.
B) none of its realized capital gains, but all of its interest and dividend income.
C) all of its realized capital gains, and at least 90 percent of its interest and dividend income.
D) all of its realized capital gains and interest and dividend income.
Answer: C
14) Nearly all mutual funds operate as regulated investment companies. This means that
A) they are no-load funds.
B) portfolio decisions are mandated by government authorities.
C) they do not pay taxes on their income.
D) their investments are guaranteed by the FDIC.
Answer: C
15) What are some of the advantages of investing through mutual funds? Name at least three.
Answer: Mutual funds offer professional management and securities selection. They offer a level of
diversification that might be too costly for the small or beginning investor to achieve.
Mutual funds offer services such as automatic dividend reinvestment and exchange
privileges.
Question Status: New
1) With a closed-end mutual fund, investors purchase shares directly from the fund.
Answer: FALSE
2) The purchase price of a closed-end mutual fund is equivalent to the net asset value of the fund.
Answer: FALSE
3) The discount or premium on a closed-end mutual fund can be as much as 25 percent.
Answer: TRUE
4) An exchange-traded fund is a closed-end fund that trades like a listed security on a stock
exchange.
Answer: FALSE
5) Like ordinary stocks, exchange traded funds (ETFs) can be sold short.
Answer: TRUE
6) An investor who buys shares in an exchange-traded fund (ETF) in the morning will pay the net
asset value at the close of trading for the day.
Answer: FALSE
7) Most exchange-traded funds are index funds.
Answer: TRUE
8) Mutual fund fees are disclosed in the fund prospectus.
Answer: TRUE
9) The net asset value is the price per share an investor will pay to acquire shares in a no -load,
open-end fund.
Answer: TRUE
10) The longer you intend to hold a fund, the more willing you should be to accept a front -end load

charge in exchange for lower annual management and 12(b)-1 fees.
Answer: TRUE
11) An open-end investment company
A) is involved in all trades of its shares.
B) sells shares at a discounted NAV price.
C) trades like a stock on the exchanges.
D) has a set number of shares.
Answer: A
12) The net asset value of a mutual fund increased from $12.03 to $13.53, but its price per share
increased by only $1.26. This information indicates that the fund
A) paid out $1 in capital gains.
B) paid out $1 in dividends.
C) is a closed-end fund.
D) is an open-end fund.
Answer: C
13) Which of the following characteristics apply to closed-end mutual funds?
I. unlimited number of outstanding shares
II. transactions between shareholders
III. market prices in excess of NAV
IV. fund repurchase of shares at any time
A) I and IV only
B) II and III only
C) I, II and III only
D) II, III and IV only
Answer: B
14) Closed-end funds are
A) less liquid than open-end funds.
B) best purchased when they are selling at a premium.
C) purchased directly from the fundsʹ manager.
D) traded at NAV.
Answer: A
15) Which one of the following statements concerning ETFs is correct?
A) ETFs are based solely on US indexes.
B) The ETF based on the Standard & Poors 500 Index is priced at 1/10 the value of that index.
C) Spiders are based on the DJIA.
D) The ETF based on the Dow is priced at 1/10 of the value of the DJIA.
Answer: B
Question Status: Revised
16) Which of the following statements is(are) correct concerning exchange-traded funds (ETFs)?
I. You can buy and sell ETFs any time during trading hours.
II. ETFs are actively managed.
III. ETFs have high portfolio turnover rates.
IV. ETFs rarely distribute any capital gains.
A) I, II and IV only
B) I and IV only
C) II and III only
D) I only
Answer: B
17) The commission charged when shares of an open-end mutual fund are purchased is called a
A) management fee.
B) back-end load.
C) front-end load.
D) 12(b)-1 fee.
Answer: C
18) Back-end loads
A) are charged when an investor buys their mutual fund shares.
B) are charged if an investor sells his or her shares within the first few years.
C) were designed to help no-load funds cover their marketing expenses.
D) encourage short-term trading.
Answer: B
19) One characteristic of 12(b)-1 charges is that they are payable
A) only in years that the mutual fund shows an increase in net asset value.
B) each year regardless of the performance of the mutual fund.
C) only during the first year the fund is owned.
D) only when shares in the fund are sold.
Answer: B
20) Two mutual funds are quoted in the newspaper as follows.
Fund A NAV 17.13 Offer Price 18.18

Fund B NAV 19.03 Offer Price 19.03
Given these quotes, which one of the following is true?
A) Both funds are load funds.
B) Fund A is a no-load fund.
C) Fund B is a no-load fund.
D) Both funds are no-load funds.
Answer: C
21) A type of fund that invests in real estate and/or mortgages is known as a
A) REIT.
B) ETF.
C) sector fund.
D) hedge fund.
Answer: A
22) A ʺtʺ in the newspaper behind a fundʹs name indicates that the fund charges a
A) front-end load.
B) back-end load.
C) front-end load and also a 12(b)-1 fee.
D) back-end load and also a 12(b)-1 fee.
Answer: D
23) A long-term mutual fund investor should normally purchase
A) A shares.
B) B shares.
C) C shares.
D) any type of share as the costs are the same over the long term.
Answer: A
24) Mutual funds can carry a number of different types of sales charges and fees. Briefly explain the
following such expenses.
(a) a front-end load
(b) a back-end load
(c) a 12(b)-1 fee
Answer: (a) A front-end load is a sales commission that is charged when an investor purchases a

load fund. The charge can be substantial (up to 8 1/2 percent of the purchase price of the
shares).
(b) A back-end load is a sales commission that is charged when an investor sells shares in a
fund. The load may be as much as 7 1/4 percent, but back -end loads tend to decline each
year, generally disappearing after 5 or 6 years.
(c) 12(b)-1 fees are known as hidden loads. They are assessed each year the fund is owned,
regardless of the fundʹs investment performance. They can amount to as much as 1 percent
per year.
25) Explain why closed-end funds can sell at prices other than the fundʹs NAV.
Answer: Closed-end funds have a set amount of shares outstanding. The market price is determined
by the economic forces of demand and supply, which are in turn affected by changes in the
NAV, the market outlook, and investor expectations. Beyond normal competitive pressures,
other factors that lead to discounts (and premiums) include the fundʹs relative performance,
its annual payout or yield, the name recognition of the fundʹs manager, fund asset liquidity,
and/or a substantial amount of unrealized appreciation in the fundʹs portfolio.
26) Use this table to answer the following questions.
NAV Fund Name Inv. Obj. Max Init. Chrg. Exp. Ratio

10.28 Fund A Growth 4.75 0.95
11.88 Fund B Aggr. Gro. 0.00 1.50
10.22 Fund C Income 6.50 0.86
16.04 Fund D Income 1.00 1.00
(a) Which fund does not charge a front-end load?
(b) Which fund can best be described as a low-load fund?
(c) What can you say about Fund B with respect to the type of investments it most likely holds?
(d) If you want to buy a fund and hold it for five years, which one of these funds should you
purchase based on fund costs? Assume the funds earn a positive rate of return each year.
Answer: (a) Fund B does not charge a front-end load.

(b) Fund D is a low-load fund.
(c) Fund B probably holds small-cap stocks that are speculative and volatile in nature. The
fund is seeking stocks that will have high capital appreciation.
(d) Fund D appears to be the lowest cost fund for a five year period, assuming a positive
rate of return each year.
27) What are the primary disadvantages of owning mutual fund shares?
Answer: The primary disadvantages are the fund costs and the lack of control over capital gain
distributions.
1) The primary objective of growth mutual funds is capital appreciation with a high level of current
income.
Answer: FALSE
2) A GNMA bond fund distributes both interest and principal on a monthly basis.
Answer: TRUE
3) The maximum average maturity of the holdings within a money market account must be 6 months
or less.
Answer: FALSE
4) Socially responsible funds tend to underperform the market.
Answer: TRUE
5) A unit investment trust
A) engages in short-term trading within a particular sector.
B) offers a low-cost, diversified portfolio.
C) is an unmanaged portfolio of securities.
D) is used only for fixed-income securities.
Answer: C
6) Which of the following statements are correct concerning hedge funds?
I. Hedge funds are highly-regulated, professionally-managed portfolios.
II. Hedge funds are actually limited partnerships.
III. Hedge funds cater to high net worth individuals and institutional investors.
IV. Hedge funds primarily adhere to a buy-and-hold conservative strategy.
A) I and II only
B) III and IV only
C) II and III only
D) I, II, and III only
Answer: C
7) Risk-seeking investors seeking maximum capital appreciation with little, if any current income,
should invest in
A) value funds.
B) growth funds.
C) aggressive growth funds.
D) equity-income funds.
Answer: C
8) An aggressive growth mutual fund is least likely to purchase a stock
A) with a high P/E ratio.
B) with a high anticipated rate of growth.
C) of an unseasoned firm.
D) with a high current yield.
Answer: D
9) Aggressive mutual funds often employ investing strategies such as
I. short selling.
II. margin trading.
III. option trading.
IV. hedging.
A) I and III only
B) II and III only
C) I, II, and IV only
D) I, II, III and IV
Answer: D
10) Value funds seek stocks
I. with low dividend yields.
II. with potential for growth.
III. with low P/E ratios.
IV. of newly discovered firms.
A) I and III only
B) II and III only
C) II, III and IV only
Answer: B
11) The primary objective of an equity-income fund is
A) capital gains.
B) current income with capital preservation.
C) potentially high capital gains with limited income.
D) high risk-return trade-offs.
Answer: B
12) Which type of mutual fund consists of both stocks and bonds with a combined objective of current
income and long-term capital gains?
A) equity-income
B) balanced
C) value
D) bond
Answer: B
13) One characteristic of bond funds is the
A) requirement of a minimum initial investment of $5,000 or more.
B) high anticipated short-term growth potential.
C) fluctuation in value in response to changing interest rates.
D) extremely aggressive trading approach.
Answer: C
14) One advantage gained by investing in a bond fund rather than in individual bonds is the
A) ability to earn fully compounded rates of return.
B) government guarantee protecting the bond principal.
C) ability to earn a capital gain.
D) guarantee that the bonds will be held to maturity to avoid market fluctuations.
Answer: A
15) Investors who seek triple (federal, state, and local) tax-free income should invest in __________
bond funds.
A) convertible
B) indexed
C) mortgage-backed
D) single-state municipal
Answer: D
16) Compared to yields on general purpose money funds, the yields on tax -exempt money funds are

A) about the same.
B) 5 to 10 percent higher.
C) 5 to 10 percent lower.
D) 20 to 30 percent lower.
Answer: D
17) Government securities money funds are structured to eliminate
A) interest rate risk.
B) inflation risk.
C) default risk.
D) market risk.
Answer: C
18) A fund that is designed to match the performance of a measure such as the S & P 500 or the Russell
2000 is called a(n)
A) index fund.
B) targeted fund.
C) sector fund.
D) block fund.
Answer: A
19) One characteristic of most index funds is that such funds typically
A) produce a large dollar amount of realized capital gains every year.
B) have a very low-cost structure with respect to management fees and transaction fees.
C) charge high front-end loads.
D) are designed to ʺbeat the market.ʺ
Answer: B
20) Socially responsible funds are distinguished from other mutual funds because they
A) invest only in over-the-counter stocks.
B) do not charge any sales commission or management fees.
C) invest only in companies that meet specified moral, ethical, or environmental standards.
D) will sell their shares only to investors who sign a statement saying they do not smoke tobacco
or use alcohol.
Answer: C
21) Sector funds generally
I. seek capital gains.
II. seek current income.
III. are speculative in nature.
IV. concentrate in one industry.
A) I and IV only
B) II and IV only
C) I, III and IV only
Answer: C
22) One type of mutual fund spreads investorsʹ money across equity markets, bond markets, and
money markets. Moreover, as market conditions change, the amount of money invested in each
market sector will change. This type of mutual fund is known as a(n)
A) socially responsible fund.
B) fiscally responsible fund.
C) growth-and-income fund.
D) asset allocation fund.
Answer: D
23) Which one of the following statements is correct concerning international funds?
A) A devaluation of the dollar causes returns on foreign investments to improve from a U.S.
perspective.
B) International funds are considered low-risk investments.
C) Balance-of-trade positions do NOT affect the rate of return from a U.S. perspective.
D) Technically, global funds can only invest in foreign securities.
Answer: A
24) Every mutual fund has a stated investment objective. Disclosure of the investment objective is
required by the SEC, and is used to classify a mutual fund into one of several categories. Briefly
explain the investment objective of each of the following categories.
(a) growth funds
(b) aggressive growth funds
(c) equity-income funds
(d) balanced funds
Answer: (a) Growth funds seek capital appreciation through long -term growth and capital gains.

They offer little, if any, current income.
(b) Aggressive growth funds seek capital gains and are considered speculative in nature.
(c) Equity-income funds seek current income by investing in high-yielding common stocks.
Capital preservation is a secondary objective.
(d) Balanced funds hold a portfolio of both stocks and bonds for the purpose of generating
both current income and long-term capital gains.
1) Automatic investment plans makes it easier for investors to save money.
Answer: TRUE
2) Even though a mutual fund investor reinvests 100% of his or her dividend and capital gains
distributions, the IRS will treat the distributions as cash receipts and tax them in the year in which
they are received.
Answer: TRUE
3) The conversion privilege offered by many mutual funds enables investors, within three days, to
convert their shares back to cash in an amount equal to the original cost of the investment.
Answer: FALSE
4) Systematic withdrawal plans from mutual funds usually require a minimum investment of at least
$100,000.
Answer: FALSE
5) The ability to automatically buy additional fund shares using the dividend income generated by
the fund is called a(n)
A) automatic investment plan.
B) automatic reinvestment plan.
C) systematic withdrawal plan.
D) conversion plan.
Answer: B
6) Typical services offered by mutual funds include:
I. automatic investing from a payroll withholding plan.
II. automatic reinvestment of dividends and capital gains.
III. systematic withdrawal plans.
IV. automatic transfers from one fund type to another when market conditions change .
A) I and III only
B) II and IV only
C) I, II, and III only
D) I, II, III, and IV
Answer: C
7) Automatic reinvestment plans
A) are a good way to avoid taxes on dividends and capital gains.
B) may involve exceptionally high transaction fees.
C) do not allow for the purchase of fractional shares.
D) are an excellent way to accumulate wealth through disciplined investing.
Answer: D
8) The conversion privilege provided by mutual fund families allows investors to
A) move from one fund to another without incurring any capital gains tax liability.
B) be more aggressive since they can re-allocate their funds when market conditions change.
C) re-allocate their funds at any time as long as they pay an additional sales load on the
transferred funds.
D) move from one fund family to another once every six months.
Answer: B
1) Mutual funds are used extensively as retirement investments.
Answer: TRUE
2) Investors should select mutual funds that match their personal investment goals and provide the
services they desire.
Answer: TRUE
3) To maximize returns, investors should generally invest in no-load or low-load funds.
Answer: TRUE
4) Much of the success of a mutual fund depends on the investment skills of the fund manager.
Answer: TRUE
5) An investor who wants to use mutual funds as a storehouse of value should invest in
A) high-yield corporate bond funds and growth funds.
B) growth funds and equity-income funds.
C) equity-income funds and long-term bond funds.
D) money funds and short-term bond funds.
Answer: D
6) Investors use mutual funds for which of the following reasons?
I. to accumulate wealth
II. to minimize risk
III. as a speculative vehicle
IV. as a storehouse of value
A) I and II only
B) II, III and IV only
C) I, II and IV only
Answer: D
7) Leverage funds, option funds and emerging-market funds are all
A) international funds.
B) no-load funds.
C) aggressive funds.
D) tax-advantaged funds.
Answer: C
8) Which of the following accurately describe reasons for investing in mutual funds?
I. to effectively control the timing of capital gains for tax purposes
II. to achieve portfolio diversification at a reasonable cost
III. to invest in unfamiliar sectors or geographic regions
IV. to outperform the market
A) I and IV only
B) II and III only
C) I, II and III only
Answer: B
9) A mutual fund is generally more tax efficient when it has a __________ turnover rate and a
__________ dividend yield.
A) low; low
B) low; high
C) high; low
D) high; high
Answer: A
1) As a general rule, the time to buy a closed-end mutual fund is when the fundʹs premium is
approximately 5 percent higher than its past average.
Answer: FALSE
2) A closed end fund is selling at a premium when the NAV exceeds the market price.
Answer: FALSE
3) A closed-end fund with an NAV of $9.60 and a market price of $10.25 is selling at a premium of
6.8%.
Answer: TRUE
Question Status: Revised
4) Closed-end funds are required to provide a prospectus to all new shareholders as long as the fund
is trading at a premium.
Answer: FALSE
5) IPOs for closed-end funds are priced at NAV.
Answer: FALSE
6) Both realized and unrealized capital gains from mutual fund investments are currently taxable for
individual income tax purposes.
Answer: FALSE
7) Both the performance of the overall stock market as well as the skills of the mutual fund manager
affect the performance of a mutual fund.
Answer: TRUE
8) Holding period returns are normally used only for investment periods of one year or less.
Answer: TRUE
9) Last year, Sue purchased a closed-end mutual fund that was trading at $42 and had an NAV of
$38. Sue sold the fund today when the NAV is $44 and the market price is $43. The fund paid $1 in
dividends over the past year. What is the Sueʹs holding period return?
A) 4.8%
B) 7.1%
C) 11.6%
D) 18.4%
Answer: A
10) Investors are generally well advised to avoid mutual funds with
A) highly rated fund managers.
B) low fees and high tax efficiency.
C) consistently poor historical performance.
D) good performance in both up and down markets.
Answer: C
11) Which of the following are sources of income for an open-end mutual fund?
I. dividend and interest income
II. change in the discount or premium
III. capital gains
IV. change in NAV
A) I and III only
B) I, II and III only
C) I, III and IV only
Answer: C
12) Income distributed by a mutual fund from which one of the following sources receives a
preferential tax rate of 15%?
A) dividends on common stock
B) interest on bonds
C) dividends from most preferred stocks
D) dividends from REITs
Answer: A
13) Last year at this time, a mutual fund had an NAV of $13.20 per share. Over the past year the fund
paid dividends of $0.70 per share and had a capital gains distribution of $1.20 per share. What is
the holding period return assuming that the current NAV is $14.42?
A) 13.2%
B) 14.4%
C) 21.6%
D) 23.6%
Answer: D
14) Information for ABC Fund is
Beginning of the Year End of the Year
NAV $12.80 $11.64
Market price of the fund shares $13.05 $9.95
Dividends paid over the year $0.90
Capital gains distributed over the year $0.30
The market-based holding period return for ABC Mutual Fund is
A) -19.1%.
B) -14.6%.
C) 0.3%.
D) 9.4%.
Answer: B
15) What is the average annual compound rate of return for a fund with the following values?
Fund price, beginning of year 1 $19.32
Fund price, end of year 3 $21.22
Annual distribution, year 1 $1.34
A) 10.5%
B) 10.8%
C) 25.6%
D) 32.3%
Answer: A
16) Mutual fund investors are primarily exposed to __________ and __________ risks.
A) market; financial
B) market; inflation
C) business; financial
D) business; inflation
Answer: B

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Chapter 12

10) The longer you intend to hold a fund, the more willing you should be to accept a front -end load

Fund A NAV 17.13 Offer Price 18.18

Answer: (a) A front-end load is a sales commission that is charged when an investor purchases a

NAV Fund Name Inv. Obj. Max Init. Chrg. Exp. Ratio

Answer: (a) Fund B does not charge a front-end load.

16) Compared to yields on general purpose money funds, the yields on tax -exempt money funds are

Answer: (a) Growth funds seek capital appreciation through long -term growth and capital gains.

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