Identify Investment Cost Structures - Series 7

1. What is the definition of a sales charge (load) on a mutual fund purchase?

   A fee paid by the investor, typically a percentage of the offering price. This charge compensates the fund for distribution costs and is deducted from the investor's purchase amount.

2. What is the formula for mutual fund offering price given NAV and a sales charge rate?

   Offering price $=\frac{\text{NAV}}{1-\text{sales charge rate}}$. This calculation adjusts the net asset value upward to incorporate the sales charge, determining the public price.

3. Identify the mutual fund fee term that represents annual operating costs stated as a percentage of assets.

   Expense ratio. It measures the fund's total annual expenses relative to average net assets, indicating operational efficiency.

4. What is the sales concession in an underwriting, in terms of who receives it and for what?

   Compensation paid to the selling firm/rep for distributing the new issue. This portion of the underwriting spread rewards the selling group for their role in marketing and placing the securities with investors.

5. What mutual fund share class typically uses a CDSC and higher ongoing distribution fees?

   Class B shares. These shares defer the sales load to redemption while applying elevated fees to cover ongoing distribution costs.

6. Which annuity fee is charged for optional benefits such as enhanced death benefits or living benefits?

   Rider fee (optional benefit charge). It covers the cost of additional protections or guarantees elected by the contract owner beyond standard features.

7. What is a surrender charge in a variable annuity or other deferred annuity contract?

   A fee for withdrawals during the surrender period, usually declining over time. This charge penalizes early withdrawals to recover distribution costs and encourage long-term holding in annuities.

8. What does a mutual fund letter of intent (LOI) allow an investor to receive immediately?

   Breakpoint pricing based on a commitment to invest a stated amount. An LOI enables investors to qualify for immediate breakpoint reductions based on a binding future investment commitment.

9. What is the maximum annual $12\text{b-}1$ distribution fee allowed for a fund marketed as "no-load"?

   At most $0.25\%$ per year. FINRA rules limit this fee to maintain the 'no-load' designation, ensuring minimal distribution costs for such funds.

10. What is the maximum total annual $12\text{b-}1$ fee (distribution plus service) permitted under FINRA rules?

    At most $1.00\%$ per year. FINRA caps the combined fees to prevent excessive charges that could erode investor returns.

11. What is the maximum annual $12\text{b-}1$ service fee component commonly permitted for shareholder servicing?

    At most $0.25\%$ per year. This limit ensures the service component remains reasonable for activities like account maintenance without exceeding regulatory thresholds.

12. What is the typical transaction cost component built into municipal bond pricing in the secondary market?

    A markup or markdown included in the net price (not a commission). Municipal bonds trade on a net basis in the secondary market, embedding the dealer's compensation directly into the price.

13. Which annuity fee compensates the insurer for guaranteed death benefits and insurance risk?

    Mortality and expense risk (M&E) charge. It covers the insurer's risks associated with mortality guarantees and administrative expenses in variable annuities.

14. Which mutual fund share class typically has level loads via higher $12\text{b-}1$ fees and no front-end load?

    Class C shares. These shares use ongoing fees for distribution without an initial load, providing a level annual cost structure.

15. What is a breakpoint discount in Class A mutual fund shares?

    A reduced front-end sales charge at specified higher purchase amounts. Breakpoints incentivize larger investments by lowering the percentage sales charge as purchase amounts reach predefined thresholds.

16. What is a markup in a principal transaction for a customer buying securities from a dealer?

    Dealer sells to customer above market price (customer pays more). Represents the dealer's profit by selling securities to the customer at a price higher than the current market value, increasing the customer's cost.

17. What is the FINRA mark-up policy concept used to judge fairness of markups and markdowns?

    The 5% Policy: a guideline for reasonable markups/markdowns. FINRA uses this policy as a benchmark to ensure markups and markdowns are fair and not excessive in principal transactions.

18. What is a front-end load mutual fund share class typically called?

    Class A shares. These shares impose the sales load at purchase to cover upfront distribution expenses.

19. Which annuity fee is charged for selecting and managing the separate account investment options?

    Separate account (subaccount) management fee. This fee compensates for the professional management of investment portfolios within the annuity's separate accounts.

20. What is a back-end load assessed on mutual fund shares called when it declines over time?

    A contingent deferred sales charge (CDSC). This fee structure discourages early redemptions by charging upon sale, with the charge decreasing based on holding period.

21. What does rights of accumulation (ROA) allow a mutual fund investor to count toward breakpoints?

    Existing holdings plus new purchases when determining breakpoint eligibility. ROA combines current and prior investments to qualify for lower sales charges, rewarding long-term investors.

22. What is a markdown in a principal transaction for a customer selling securities to a dealer?

    Dealer buys from customer below market price (customer receives less). Represents the dealer's profit by purchasing securities from the customer at a price lower than the current market value, reducing the customer's proceeds.

23. What is the best reference price for computing a bond markup or markdown in an active market?

    The dealer's contemporaneous cost (or proceeds) for the same security. This price reflects the most accurate market value for calculating fair compensation in active bond markets under FINRA rules.

24. What is a $12\text{b-}1$ fee in a mutual fund, in terms of what it pays for?

    An annual distribution/marketing fee charged against fund assets. This fee, authorized under SEC Rule 12b-1, allows funds to deduct expenses for promoting and distributing shares from fund assets.

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