- A client in a taxable account uses a mutual fund family's exchange privilege to move her entire holding from the family's growth fund into the family's bond fund. The exchange is made at NAV and no new sales charge is imposed. Which statement is correct for federal income tax purposes in tax year 2026?
Answer: The exchange is a taxable sale of the old shares and a purchase of the new shares, so any realized gain is currently taxable.
Under IRC § 1001, an exchange of mutual fund shares is a taxable disposition and a new purchase; the basis does not carry over to the new shares. The fact that no cash changes hands and the exchange is at NAV does not make it tax-free. Income dividends are taxed separately and are not the trigger for gain on the exchange.
- A client has $75,000 to invest and a time horizon of about twelve years. She is choosing among share classes of the same mutual fund. Class A has a 5.0% front-end sales charge and a 0.25% annual 12b-1 fee. Class B has no front-end sales charge, a 0.75% annual 12b-1 fee, and a CDSC that starts at 5% and declines to zero after six years; the Class B shares do not convert to Class A. Class C has no front-end sales charge, a 1.00% annual 12b-1 fee, and no CDSC. All classes invest identically before fees. Which share class is generally most appropriate?
Answer: Class A, because over a twelve-year holding period the annual 12b-1 fee savings outweigh the one-time front-end sales charge, even though the Class B CDSC would already be gone.
Under standard mutual fund sales-charge analysis, the relevant comparison is the total cost of holding the shares. Over a twelve-year horizon, Class A's 5.0% front-end load is a one-time cost and its 0.25% annual 12b-1 fee is 0.50% lower than Class B's and 0.75% lower than Class C's; the annual savings are enough to outweigh the front-end charge. The fact that Class B's CDSC has expired by year 12 removes only the redemption charge, not the higher 0.75% annual fee. Class C's absence of a sales charge does not offset its highest annual fee. Class A does not waive its 12b-1 fee after the load is paid, and no single class is least costly over every holding period.
- Which statement regarding a limit order to buy exchange-traded fund (ETF) shares and an order to buy shares of a no-load open-end mutual fund is true?
Answer: The ETF order fills only when a seller is willing to trade at or below the limit price; the mutual fund order fills at the next NAV computed after the fund receives the order.
An open-end fund is subject to forward pricing under SEC Rule 22c-1: a purchase order received during the day executes at the next NAV computed after the fund receives the order. ETF shares, by contrast, trade on an exchange at negotiated market prices, so a buy limit order fills only when a seller is willing to trade at or below the limit price. The statement that the ETF order executes at the ETF's NAV is wrong because NAV is not the execution price for an exchange order. The statement that the mutual fund order executes at the most recently computed NAV before receipt is wrong because forward pricing uses the next NAV after receipt. The statement that both orders fill at the next NAV incorrectly applies mutual fund pricing to the ETF, and the statement that the ETF fills at closing NAV while the mutual fund fills at market price reverses both pricing conventions.
- At 2:15 p.m. Eastern Time on a business day, an investor places a $10,000 purchase order for an open-end mutual fund and a separate $10,000 market order for an exchange-traded fund. The mutual fund computes its NAV once daily at the close of trading; the ETF is quoted $58.10 bid/$58.35 ask and last traded at $58.20. How will the two orders be executed?
Answer: The mutual fund will be filled at that day's closing NAV; the ETF will be filled at the current ask price, not at the ETF's NAV.
Under Investment Company Act Rule 22c-1, an open-end fund must execute a purchase at the NAV next computed after receipt, so the 2:15 p.m. order receives that day's close-of-trading NAV. An ETF trades in the secondary market; a buy market order is filled at the best available ask, not at the ETF's NAV. The statement that both orders receive the close-of-trading NAV ignores the ETF's exchange-traded structure. The prior-day NAV statement misapplies forward pricing, and the next-business-day NAV statement is wrong because the next computed NAV is that same day, not the following business day.
- An investor owns units of a unit investment trust and needs cash before the trust's termination date. Which statement is correct?
Answer: The units may be tendered to the trustee for redemption at net asset value, and the proceeds may be less than the original cost.
Under the Investment Company Act of 1940, UIT units are redeemable securities. A unit holder may tender the units to the trustee and receive a redemption price based on the net asset value of the underlying securities, which can be below the original cost. The statement that the investor must sell the units on an exchange is wrong: units of a UIT are redeemable securities, so the holder is not required to use an exchange, although a sponsor may maintain a secondary market. The statement that the investor may surrender units to the sponsor for the original public offering price reduced only by income distributions is wrong: both sponsor repurchases and trustee redemptions are priced from current net asset value, and the original offering price is not guaranteed. The statement that liquidation must wait until termination is wrong: the fixed, unmanaged portfolio does not prevent pre-termination redemption.
- Which statement is correct regarding the costs typically associated with a no-load open-end mutual fund compared with an exchange-traded fund?
Answer: An ETF investor may pay a brokerage commission and a bid-ask spread, while a no-load mutual fund investor who buys directly from the fund avoids a sales charge; both pay operating expenses.
Mutual fund and ETF operating expenses are deducted from fund assets, so both have expense ratios; no-load refers only to the absence of a sales charge, not to the absence of management fees. A no-load fund still has management and administrative fees, and an ETF investor bears the fund's operating expenses through a lower NAV. ETF shares trade on an exchange, so an ETF investor may pay a brokerage commission and the bid-ask spread, while an investor buying a no-load fund directly from the fund family avoids a sales charge and does not pay an exchange spread. The statement that a no-load fund pays a bid-ask spread is wrong because open-end fund orders are executed at NAV, and the statement that an ETF has no ongoing fund operating expenses is wrong because ETFs have expense ratios. A no-load fund also has management fees, and retail ETF investors do not create or redeem shares directly with the fund at NAV.
- Eighteen months ago, an investor bought Class B shares of a mutual fund. She now redeems all of them. The fund's CDSC schedule begins at 5% in year 1 and declines by one percentage point each year. The prospectus also imposes a 2% redemption fee on shares held 90 days or less. Which statement is correct?
Answer: The redemption is subject to a 4% CDSC paid to the distributor; the 2% redemption fee does not apply because the holding period exceeds 90 days.
Under the mutual fund sales-charge and redemption-fee framework, a CDSC is a contingent deferred sales charge paid to the distributor when shares are redeemed during the CDSC period. At eighteen months, the charge is 4%. The 2% redemption fee applies only to shares held 90 days or less, so it is not charged. The statement that both charges are paid to the fund is wrong: a CDSC compensates the distributor, while a redemption fee, when imposed, is paid to the fund for remaining shareholders.
- At the end of the day, a mutual fund has total assets of $520 million and total liabilities of $20 million. The fund has 25 million shares outstanding. Its prospectus states a maximum sales charge of 6%. What is the public offering price per share?
Answer: $21.28 per share
Under standard mutual fund pricing, NAV equals total assets minus liabilities divided by shares outstanding: NAV = ($520 million - $20 million) / 25 million shares = $20.00. The sales charge is a percentage of the offering price, so POP = $20.00 / (1 - 0.06) = $21.28. The $21.20 figure multiplies NAV by 1.06, treating the load as if it were added to NAV. The $22.05 figure repeats that error using the asset-only $20.80 figure. The $20.80 figure ignores liabilities and is not a public offering price.
- An equity ETF and a comparable open-end mutual fund have similar portfolios, and both are registered investment companies. Which statement best explains why the ETF is likely to distribute smaller capital gains to its shareholders?
Answer: In-kind redemptions let the ETF transfer appreciated securities to authorized participants instead of selling them, reducing realized gains.
Under the tax rules for regulated investment companies, an ETF is not exempt from distributing net capital gains. In-kind redemptions allow the ETF to transfer appreciated securities to authorized participants instead of selling them, so fewer portfolio gains are realized and fewer gains must be distributed. The statement that ETFs generally hold only non-dividend-paying securities is wrong; many ETFs hold dividend-paying securities, and dividends are not capital gains. The statement that ETF shares are not redeemable is wrong; ETF shares are redeemable in creation units by authorized participants.
- A client is considering a unit investment trust that holds a fixed portfolio of municipal bonds. Which statement about this UIT is correct?
Answer: Units are redeemable with the trustee at the current NAV, and the sponsor may maintain a secondary market for units.
Under the Investment Company Act of 1940, a unit investment trust is organized under a trust indenture, issues only redeemable securities, and holds a fixed portfolio; units are redeemable with the trustee at NAV, and the sponsor may maintain a secondary market. The statement that the trust is actively managed is wrong: UITs are not actively managed. The statement that a UIT has no termination date is wrong; a UIT has a stated termination date. The statement that principal is withheld until termination is wrong; principal from maturing securities is distributed to unit holders as it is received.
- All of the following are characteristics of a unit investment trust EXCEPT:
Answer: It continuously offers new units and actively substitutes portfolio securities in response to changing market conditions.
Under the Investment Company Act of 1940, a unit investment trust is a registered investment company that issues redeemable securities representing an undivided interest in a fixed portfolio, is unmanaged, has no board of directors, and has a stated termination date. A continuously offered, actively managed portfolio describes an open-end management company, not a unit investment trust.
- Which statement is correct regarding capital gain distributions from an exchange-traded fund compared with a traditional open-end mutual fund?
Answer: An ETF is generally more tax-efficient than an open-end mutual fund because in-kind redemptions allow the ETF to transfer low-basis securities to authorized participants rather than selling securities to meet redemptions.
Under the Internal Revenue Code rules for regulated investment companies, an ETF generally avoids recognizing gain on in-kind redemptions. A traditional open-end fund may be forced to sell portfolio securities to meet redemptions, realizing gains that are passed through to remaining shareholders. An ETF typically satisfies redemptions by delivering portfolio securities to authorized participants in creation-unit sizes, and that in-kind delivery is generally not a taxable sale by the fund, so fewer capital gains are distributed. The statement that the two fund types have identical capital gain distributions is wrong: the RIC distribution requirement addresses net investment income and does not make capital gain pass-throughs identical, and open-end funds are more likely to realize gains when meeting redemptions. ETF shareholders can still receive capital gain distributions and owe tax when they sell their shares, and the fund does not pay the tax when it satisfies the regulated investment company distribution requirements. The in-kind transfer is not treated as a sale generating losses, and ETFs do not avoid capital gain distributions entirely.
- An exchange-traded fund's shares are trading at a 2% premium to its NAV. Under normal market conditions, which of the following would most likely occur?
Answer: Authorized participants buy the portfolio basket, deliver it to create new ETF shares, and sell those shares in the secondary market, pushing the market price down toward NAV.
Under the ETF creation-redemption mechanism, authorized participants arbitrage premiums and discounts by transacting in creation units. A premium attracts APs to buy the portfolio basket, create new shares, and sell those shares in the secondary market, increasing supply and pushing the market price back toward NAV. The statement describing redemption is the discount-side mechanism. Retail investors do not redeem ETF shares directly with the fund at NAV, and ETF shares are not fixed in supply like closed-end fund shares.
- An open-end fund charges a 0.25% annual 12b-1 fee, imposes no front-end load, and has no CDSC. The fund's distributor receives no other compensation from the fund. Which statement about the fund's 'no-load' label is correct?
Answer: The fund may call itself no-load because the annual 12b-1 fee is within the permitted ceiling and there is no sales charge.
Under SEC and FINRA rules, a fund with no sales load and a 12b-1 fee of no more than 0.25% may use the no-load label. A 12b-1 fee is deducted from fund assets and is distribution-related, not merely administrative. There is no requirement that the adviser pay the fee from its own resources, and a 0.25% 12b-1 fee is not treated as a sales load for the no-load label.
