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19 Cards in this Set
- Front
- Back
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Last year, ABC Mutual Fund paid dividends of $1.50/share and distributed $0.80/sh in capital gains. The fund has a bid price of $13.50 and an ask price of $14.20. An investor who purchased shares in this fund 9 months before the distributions receives $100 in eligible dividend income and $53 in capital gains. If this is the individual's only investment, he will:
1. not be required to pay any federal taxes on the dividend income. 2. be required to pay federal taxes at the ordinary income rate on the dividend income. 3. be required to pay capital gains tax on $53. 4. not be required to pay capital gains tax on $53. |
Answer: 2 & 3
Investors are required to pay taxes on all distributions from mutual funds, whether reinvested or received in cash. |
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A customer owns shares in ACME Income Fund and decides to exchange them for shares in ACME Growth Fund within the same family of funds. Which of the following statements is TRUE?
A) The exchange results in a deferral of tax. B) Tax or loss on the exchange cannot be determined until ACME Growth Fund is sold. C) The exchange is a taxable event. D) The exchange is a nontaxable swap. |
Answer: C
The IRS deems an exchange to be a sale and repurchase of shares. On any sale of securities, capital gains or losses are realized; as such, exchanges are a taxable event. |
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Net asset value (NAV) per share for a mutual fund can be expected to decrease if the:
A) fund has made dividend distributions to shareholders. B) securities in the portfolio have appreciated in value. C) issuers of securities in the portfolio have made dividend distributions. D) fund has experienced net redemption of shares. |
Answer: A
The NAV per share will rise or fall relative to the value of the underlying portfolio. If dividends are distributed to shareholders, the fund's assets decrease and their per-share value will decline accordingly. Appreciation of the portfolio and dividends received will increase the value. Redemption of shares will have no impact on the NAV per share as the money paid out is offset by a reduced number of shares outstanding. |
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SEC rules require that open-end management companies distribute dividends to their investors from the firm's:
A) capital gains B) gross revenue C) portfolio earnings D) net investment income |
Answer: D
Dividends must be paid from the net investment income. |
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Which of the following constitutes selling dividends?
A) Withdrawing dividends, rather than reinvesting them in additional shares. B) Encouraging investors to postpone purchases of mutual fund shares until after the ex-date for a dividend distribution. C) Enticing customers to buy mutual fund shares just before the ex-dividend date. D) Encouraging customers to sell their mutual fund shares just before the ex-dividend date. |
Answer: C
Selling dividends is an unethical sales practice in which a member intentionally misleads customers into believing they will receive the equivalent of a rebate on their investments because the fund will soon pay a distribution. The customers suffer out of pocket losses because the cash immediately coming back is dividend income, subject to tax. At the same time, the NAV of the fund is reduced. |
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Customer A and Customer B each have an open account in a mutual fund that changes a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments?
1. Receiving cash distributions may reduce Customer A's proportional interest in the fund. 2. Customer A may use the cash distributions to purchase shares later at NAV. 3. Customer B's reinvestments purchase additional shares at NAV rather than at the offering price. 4. Due to compounding, Customer B's principal will be at greater risk. |
Answer: 1 & 3
If the customer elects to receive distributions in cash while the other investors purchase shares through reinvestment, his proportional interest in the fund will decline. The option to have distributions automatically reinvested allows those purchases to be made at NAV, but a purchase made later would be at the POP like any other new purchase. |
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According to investment company rules, open-end investment companies may NOT distribute long term capital gains to their shareholders more frequently than:
A) monthly B) quarterly C) semiannually D) annually |
Answer: D
Under the Act of 1940, investment companies may not distribute LT capital gains more frequently than once/year. |
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When calculating net investment income, an investment company includes:
A) just dividends + interest B) dividends + interest - operating expenses C) only dividends D) only interest |
Answer: B
Net investment income = gross investment income - operating expenses. Gross investment income is interest and dividends received from securities in the investment company's portfolio. |
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If a customer transfers his holdings from one fund to another within the same family of funds, what are the tax consequences?
A) Gains are taxed and losses are deferred. B) Losses are deducted and gains are deferred. C) On the transaction date, any gain or loss is recognized for tax purposes. D) No gain or loss is recognized until redemption. |
Answer: C
An exchange is a taxable event. The cost basis of the shares in the original account must be compared to their redemption value. Any gain or loss is recognized in the year of the exchange. The exchange privilege allows the investor to avoid paying an additional sales charge, it does not allow the investor to avoid taxes. |
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Unrealized gain in a mutual fund portfolio does which of the following?
1. Increases the dividends paid to shareholders. 2. Represents the undistributed income and the growth in the market value of securities held in the portfolio. 3. Is realized by shareholders only when they redeem their shares. 4. Has no effect on shareholders until the annual long-term capital gains distribution is paid. |
Answer: 2 & 3
Unrealized gains result from asset appreciation and undistributed income. This increase in value is reflected in an appreciation of the mutual fund shares. Investors realize this appreciation only by selling their shares. |
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Which of the following statements describe the conduit theory of taxation?
1. A fund is not taxed on earnings it distributes provided distributions = 90% or more of net investment income. 2. Earnings distributed by a regulated investment company are taxed 3 times. 3. Dividends & interest are passed through to the investor without the fund being taxed. 4. Dividends and interest accumulate tax free to the shareholder. |
Answer: 1 & 3
Under the conduit, or pipeline, theory of taxation, a fund is liable for taxes only on the income retained, provided it distributes at least 90% of its net investment income. The investor benefits because the income is only taxed twice (at the corporate level and at the individual level), and avoids taxation at the fund level. There is no tax-free accumulation for the shareholder. |
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Last year, ABC Mutual Fund paid dividends of $1.50/share and distributed $0.80 per share in capital gains. The fund has a bid price of $13.50 and an ask price of $14.20. What is the fund's current yield?
A) 0.0492 B) 0.1 C) 0.162 D) 0.1056 |
Answer: D
Find the current yield of mutual fund shares by dividing the annual dividend by the POP (ask price): $1.50/$14.20 = 10.56% |
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Which of the following statements are TRUE of mutual fund dividend distributions?
1. The fund pays dividends from net investment income. 2. A single taxpayer may exclude $100 worth of dividend income from taxes annually. 3. An investor is liable for taxes on distributions, whether taken in cash or reinvested in the fund. 4. An investor is not liable for taxes if he automatically reinvests distributions.
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Answer: 1 & 3
Mutual funds pay dividends from net investment income and shareholders are liable for taxes on all distributions, whether reinvested or taken in cash. |
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Your customer redeemed 200 of her 500 Kapco common shares without designating which shares were redeemed. Which of the following methods does the IRS use to determine which shares she redeemed?
A) Identified shares B) Wash sale rules C) LIFO D) FIFO |
Answer: D
When a customer does not choose a method, the IRS uses FIFO (first in, first out). This will likely result in shares with the lowest cost basis being redeemed first, which creates a greater taxable gain. |
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If an investor has received dividends and capital gains distributions on mutual fund shares she has held for 4 months, the investor will pay:
A) no tax until she liquidates the shares. B) capital gains rates on capital gains distributions and ordinary income rates on dividends. C) ordinary income tax rates on the capital gains and dividends. D) LT or ST capital gains rates, depending upon the length of time the customer has held the fund shares. |
Answer: B
Capital gains distributions are taxed as capital gains, with their holding status depending upon how long the fund has held the securities, not how long the investor has held the mutual fund shares. Dividend distributions are taxed as ordinary income. |
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Capital gains distributed by a mutual fund to shareholders are reported and taxable for the year:
A) the shares are redeemed by the fund. B) paid by the fund. C) the shareholder chooses but not later than 2 years after all shares are redeemed. D) earned (accrued). |
Answer: D
Capital gains can be distributed to shareholders no more than once/year and are reported and taxable for the year earned (accrued). |
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Mutual fund shareholders are NOT taxed on:
A) reinvested dividends B) unrealized taxable gains C) capital gains distributions D) interest distributions |
Answer: B
Unrealized gains contribute to NAV appreciation and to a shareholder's capital gain upon redemption. |
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An open-end investment company that does not distribute at LEAST 90% of its net income:
A) does not require a restricted type of management. B) is unable to retain all or part of its realized capital gains. C) is liable for federal taxes on its net income. D) continues to qualify as a registered investment company based upon the interpretations of the IRS. |
Answer: C
Investment companies that do not distribute at least 90% of their net investment income become liable for federal taxes on all the net investment income. Shareholders would also be responsible for taxes on any distributions received. By distributing 90%, open-end companies can avoid double taxation. |
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Your mutual fund has sent you a Form 1099, listing some LT capital gains on which you must pay taxes. You are concerned that the 1099 is in error because you have owned your shares for only 4 months. Which of the following statements is true?
A) The 1099 is correct because the holding period to be considered is that of the investment company, not yours. B) The 1099 is incorrect because you have held your shares for less than 1 year, which indicates a ST gain. C) The gain need not be reported since you have not redeemed your shares, and therefore have not realized any gain. D) The gain need not be reported since you have instructed the company to reinvest your dividends and capital gains, thus deferring your tax liability. |
Answer: A
The investment company designated the gains as LT because the company held the securities for more than a year before selling them. The holding period on your shares is relevant only if you redeem your shares for a gain. |
