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Test Bank for Investments: An Introduction, 13th Edition Herbert B. Mayo

Test Bank for Investments: An Introduction, 13th

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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
1. A closed-end investment company is not a "mutual fund."
a. True
b. False
ANSWER: True

2. The per share net asset value of the shares in a closed-end investment company depends on the difference between the
fund's assets and liabilities and the number of shares outstanding.
a. True
b. False
ANSWER: True

3. If a closed-end investment company were liquidated, the investor should receive the net asset value minus the cost of
the liquidation.
a. True
b. False
ANSWER: True

4. A closed-end investment company’s shares cannot sell for a discount from net asset value.
a. True
b. False
ANSWER: False

5. The shares of a closed-end investment company often sell for a discount from their net asset value.
a. True
b. False
ANSWER: True

6. The discount paid for the shares of a closed-end investment company is fixed by the fund.
a. True
b. False
ANSWER: False

7. The only costs of investing in a closed-end investment company are the commissions to buy and sell the shares.
a. True
b. False
ANSWER: False

8. Distributions from an investment company may include earnings and capital gains.
a. True
b. False
ANSWER: True

9. Distributions from a closed-end investment are subject to federal income taxation.

a. True
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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
b. False
ANSWER: True

10. A unit trust is a passive investment that holds a fixed portfolio of securities such as federal government bonds.
a. True
b. False
ANSWER: True

11. Unit trusts may be self-liquidating.

a. True
b. False
ANSWER: True

12. A loading fee charged by a mutual fund does not apply to a closed-end investment company.
a. True
b. False
ANSWER: True

13. If a closed-end investment company specializes in the securities of one sector of the economy, systematic risk is
reduced.
a. True
b. False
ANSWER: False

14. Real estate investment trusts (REITs) are illustrative of a closed-end investment company.
a. True
b. False
ANSWER: True

15. The cash flow generated by REITs is taxed as income by the federal government.
a. True
b. False
ANSWER: False

16. A mortgage trust is a REIT that specializes in mortgage loans.

a. True
b. False
ANSWER: True

17. An equity REIT may not use financial leverage (i.e., its financing is entirely equity).
a. True
b. False
ANSWER: False

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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
18. The first exchange-traded funds (ETFs) were a type of index fund.
a. True
b. False
ANSWER: True

19. Since ETFs mimic an index, they do not buy individual shares of stock.
a. True
b. False
ANSWER: False

20. As a result of arbitrage, ETFs tend to sell for their net asset value.
a. True
b. False
ANSWER: True

21. An investor may not sell short the shares of an ETF.

a. True
b. False
ANSWER: False

22. Compared to selecting individual stocks, ETFs ease the process of constructing a well diversified portfolio.
a. True
b. False
ANSWER: True

23. If an investor believes that financial markets are inefficient, that argues for pursuing a more active portfolio strategy
and purchasing exchange-traded funds instead of individual stocks.
a. True
b. False
ANSWER: False

24. A leveraged ETF only buys stock in companies with substantial debt.
a. True
b. False
ANSWER: False

25. A hedge fund is a conservative type of mutual fund.

a. True
b. False
ANSWER: False

26. Hedge fund strategies may include buying one stock while shorting another.
a. True
b. False
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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
ANSWER: True

27. Hedge funds are sold primarily to high net worth investors and financial institutions such as pension plans.
a. True
b. False
ANSWER: True

28. American investors may acquire shares in mutual funds that specialize in foreign investments.
a. True
b. False
ANSWER: True

29. A global fund invests solely in foreign securities.

a. True
b. False
ANSWER: False

30. The shares of closed-end investment companies that invest in foreign securities cannot sell for a premium over their
net asset values.
a. True
b. False
ANSWER: False

31. Closed-end investment companies

1. have a fixed capital structure
2. issue new stock whenever an individual buys shares
3. may sell for a premium over net asset value
4. must sell for their net asset value
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
ANSWER: a

32. The net asset value of a closed-end investment company increases with
a. higher stock prices
b. lower stock prices
c. larger number of shares
d. increased liabilities
ANSWER: a

33. Since closed-end investment companies acquire securities in efficient financial markets, they
a. cannot outperform the market consistently
b. should not outperform the market consistently
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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
c. will underperform the market when stock prices decline
d. primarily bear unsystematic risk
ANSWER: b

34. Closed-end investment companies with beta coefficients less than 1.0
a. have outperformed the market
b. have underperformed the market
c. have more systematic risk than the market
d. have less systematic risk than the market
ANSWER: d

35. If a closed-end investment company sells for a discount,

a. its price exceeds the net asset value
b. its price is less than the net asset value
c. dividend income exceeds capital gains
d. capital gains exceed dividend income.
ANSWER: b

36. A real estate investment trust

a. pays federal income taxes
b. retains all of its earnings
c. invests in mortgages or rental properties
d. cannot use debt financing
ANSWER: c

37. Which of the following is not a consideration for investing in real estate investment trusts (REITs)?
a. fluctuations in dividend payments
b. excessive use of debt financing by some REITs
c. fluctuating interest rates affecting securities valuations
d. the federal tax rate paid by the trust
ANSWER: d

38. Exchange traded funds

a. redeem their shares
b. only buy exchangeable securities
c. are bought and sold in secondary markets
d. cannot be sold short
ANSWER: c

39. Exchange-traded funds

a. consistently outperform other funds
b. mimic an index of securities
c. require investors to select individual stocks
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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
d. are illustrations of load funds
ANSWER: b

40. Many exchange-traded funds limit their portfolios to

a. high quality securities
b. stocks that respond to changes in consumer prices (the Consumer Price Index or CPI)
c. stocks included in an aggregate measure of stock prices
d. stocks and bonds of companies in a particular industry
ANSWER: c

41. A hedge fund

a. is a public financial institution
b. has its shares registered with the Federal Reserve
c. is open to a select number of individual investors
d. has actively traded shares
ANSWER: c

42. Hedge funds follow investment strategies such as

a. acquiring shares in mutual funds
b. shorting “overvalued” stocks while buying “undervalued” stocks
c. limiting their portfolios to money market instruments
d. underwriting new issues (IPOs)
ANSWER: b

43. The portfolios of international funds

a. stress European securities
b. exclude U. S. securities
c. are a diversified mix of securities from all countries with security markets
d. specialize in the securities of one country
ANSWER: b

44. An American investor may take a position in foreign equities by acquiring

1. iShares specializing in foreign country indexes
2. international mutual funds
3. country closed-end investment companies
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
ANSWER: d

45. If an investor purchases shares in a no load mutual fund for $36, receives cash distributions of $1 and redeems the
shares after one year for $42, what is the percentage return on the investment?

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Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
ANSWER:
The percentage return: ($42–36+1)/$36=19.44%

46. The net asset value of shares in a closed-end investment company is $36. An investor buys the shares for $34 in the
secondary market. The company distributes $1 and after one year, the net asset rises to $42. The investor sells the shares
for $44 in the secondary market.
a. What is the discount?
b. What is the percentage return on the investment?
c. In both problems 1 and 2, the investment company’s net asset value rose from $36 to $42 and the company distributed
$1. Why are the percentage returns different?
ANSWER: a. The discount is $36-$34=$2 (5.9% of NAV).

b. The percentage return: ($44-34+1)/$34=32.3%

c. The percentage returns differ because initially the closed-end investment company sold for a discount of $2
from net asset value. The closed-end investment company sold for a premium of $2 above net asset value
when the shares were sold. This increase of $4 increased the percentage return on the investment.

47. If an investor buys shares in a closed-end investment company for $46 and the net asset value is $53, what is the
discount? If the company distributes $1, the net asset value rises to $58, and the investor sells the shares for a premium of
5 percent over the net asset value, what is the percentage earned on the investment?
ANSWER:
The discount is $53-46=$7 (The shares initially sell for a discount of $7/53=13.2 percent from net asset value.)

The percentage return is ($1+1.05(58)-46)/$46=34.6%.

48. A mutual fund’s net asset value is $50, but the fund charges an exit fee of 1 percent of net asset value and a load fee of
4 percent of net asset value. An individual purchases the shares. During the year the fund distributes $2.34. The net asset
value rises to $58.38 and the investor redeems the shares.

a. What is the percentage return the fund can report that was achieved by its portfolio managers?

b. What is the percentage return the individual earned on the investment?

c. Why are the two percentages different?

ANSWER:
a. The percentage return reported by the fund:
(57.80-50+2.34)/$50=20.28%.

b. The shares cost $50+.04($50)=$52. When the shares are redeemed, the investor nets $58.38(0.99)=$57.80.

The percentage return is ($57.80–52+2.34)/$52=15.65%.

c. The load fee charged when the shares are purchased and the exit fee charged when the shares are redeemed
decrease the return the investor realizes.

49. You buy a REIT for $50 a share. The REIT distributes $3.00 consisting of return of capital. You are in the 30 percent
income tax bracket (which also applies to short-term capital gains) and the 15 percent long-term capital gains bracket.
What is the tax implication of this distribution?
ANSWER: No taxes are owed since the distribution is totally a return of capital. The cost basis of the shares is reduced by
Copyright Cengage Learning. Powered by Cognero. Page 7
Test Bank for Investments: An Introduction, 13th Edition Herbert B. Mayo

Name: Class: Date:

7. Closed-End Investment Companies, Real Estate Investment Trusts (REITs), and Exchange-Traded
Funds (ETFs)
$3 to $47 ($50-$3), which will be used to determine any capital gain or loss when the shares are sold.

50. An investor bought 100 shares of a REIT for $54 a share and two years later sold the shares for $62. The REIT
annually distributed $4.00 per share ($400) consisting of $2.00 ($200) return of capital, $1.20 ($120) in income, and $0.80
($80) in long-term capital gains. The investor’s income tax bracket is 30 percent. The long-term capital gains tax rate is 15
percent. What is the investor’s second year tax obligation?
ANSWER: The annual distribution was $400 and consisted of
$200 return of capital
$120 income
$80 long-term capital gain.
The tax on the income distribution:
$120×.3=$36
The tax on the long-term capital gain: $80×.15=$12
The tax on the sale (long-term):
Cost basis: $5400-$400=$4800 after reducing the initial cost basis for the $200 return of capital for each of the
two years (a total of $400)
Capital gain: $6200-$4800=$1400
Tax on the capital gain: $1400×.15=$210.
Total tax: $36+$12+$210=$256.

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