Series 65 Investment Companies and Alternatives Practice Questions
Question 1
A client is considering a bank-issued 'principal-protected' market-linked note tied to an equity index, maturing in 7 years. Which statement about this product is most accurate?
- A. The principal protection is guaranteed by FDIC insurance, just like a bank CD
- B. Repayment of principal at maturity depends on the credit of the issuing bank, and the client bears that issuer credit risk
- C. The note can be sold at any time prior to maturity at full face value with no liquidity discount
- D. Returns are guaranteed to match the index's performance exactly, with no cap
Show answer and explanation
Correct answer: B. Repayment of principal at maturity depends on the credit of the issuing bank, and the client bears that issuer credit risk
'Principal protected' notes are unsecured debt obligations of the issuing institution — the protection is only as good as the issuer's ability to pay, meaning the investor bears issuer credit risk, unlike an FDIC-insured CD. These notes are also typically illiquid before maturity and frequently include caps or participation rates rather than uncapped exact index tracking. A confuses a structured note with deposit insurance; C and D both overstate liquidity and upside features.
- A. Structured notes are unsecured obligations of the issuing bank and are not FDIC-insured the way bank deposits or CDs are; this statement is incorrect.
- B. 'Principal protection' on a structured note is only as good as the issuing bank's ability to pay — it's an unsecured promise, so the client bears the issuer's credit risk, making this the correct statement.
- C. These notes are generally illiquid prior to maturity, and any secondary market sale would typically occur at a discount to face value, not at full face value.
- D. Returns on market-linked notes are typically capped, subject to participation rates, or otherwise limited by the note's terms — they are not an uncapped guarantee of index performance.
Question 2
Unlike shares of an open-end investment company, shares of a closed-end investment company:
- A. Are always redeemable at NAV upon demand from the fund
- B. Are sold in a continuous public offering at NAV plus a sales charge through the sponsor
- C. Trade in the secondary market at prices that may be above or below their NAV
- D. Cannot be purchased by individual retail investors
Show answer and explanation
Correct answer: C. Trade in the secondary market at prices that may be above or below their NAV
Closed-end funds conduct a one-time IPO and then trade like stocks on an exchange or over-the-counter, with market prices driven by supply and demand — meaning shares can trade at a premium or discount to NAV. Open-end funds (mutual funds), by contrast, continuously issue and redeem shares directly with the fund at NAV (plus any applicable sales charge).
- A. Describes open-end funds; closed-end shares are typically not redeemed by the fund but sold on the secondary market.
- B. Describes open-end (mutual fund) continuous offerings through a sponsor or distributor, not closed-end funds' one-time IPO structure.
- C. Correct — closed-end fund market prices can diverge from NAV since they trade on exchanges.
- D. False — closed-end funds are commonly purchased by retail investors through brokerage accounts.
Question 3
Which of the following correctly distinguishes how ETF shares are bought and sold from how open-end mutual fund shares are bought and sold?
- A. ETF shares are priced once daily and purchased at the next computed NAV, while mutual fund shares trade continuously at negotiated prices
- B. ETF shares trade throughout the day on an exchange at negotiated market prices, while mutual fund shares are bought and sold at the next computed end-of-day NAV
- C. ETF shares cannot be sold short, while mutual fund shares can be sold short at any time
- D. Mutual fund shares trade intraday on an exchange, while ETF shares are only priced once per day
Show answer and explanation
Correct answer: B. ETF shares trade throughout the day on an exchange at negotiated market prices, while mutual fund shares are bought and sold at the next computed end-of-day NAV
ETFs are listed on an exchange and trade continuously during market hours at prices set by supply and demand (kept close to NAV through arbitrage); open-end mutual fund shares use forward pricing and are bought or sold only at that day's closing NAV. Choices A and D reverse this relationship, and ETF shares can, in fact, be sold short like other exchange-listed securities.
- A. This reverses the two products: mutual funds price once daily at NAV, while ETFs trade continuously — the statement describes each product backwards.
- B. ETFs trade intraday on an exchange at market-negotiated prices, while open-end mutual funds transact only at the next computed end-of-day NAV, which is the accurate distinction.
- C. ETFs can be sold short like other exchange-listed securities; open-end mutual fund shares generally cannot be sold short, the opposite of what's stated.
- D. This also reverses the facts — mutual funds don't trade intraday on an exchange, and ETFs are priced continuously, not once per day.
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What is the key structural difference between an open-end investment company (mutual fund) and a closed-end investment company with respect to how shares are priced and traded?
- A. Open-end fund shares are bought and sold at NAV; closed-end fund shares trade on an exchange at a market price that may differ from NAV
- B. Closed-end fund shares are generally redeemed by the fund company at NAV, while open-end shares trade on an exchange at a market price set by the fund's board
- C. Both fund types generally transact at NAV, because exchange arbitrage eliminates any premium or discount on closed-end fund shares
- D. Open-end funds have a fixed number of shares outstanding, while closed-end funds continuously issue new shares
Show answer and explanation
Correct answer: A. Open-end fund shares are bought and sold at NAV; closed-end fund shares trade on an exchange at a market price that may differ from NAV
Open-end funds continuously issue and redeem shares directly with the fund at the next-computed net asset value (NAV) per share. Closed-end funds issue a fixed number of shares in an IPO and thereafter trade on a secondary exchange at whatever price buyers and sellers agree upon, which can be a premium or discount to the fund's underlying NAV.
- A. Correct. This correctly describes NAV-based open-end pricing versus market-based closed-end pricing.
- B. Incorrect. This reverses the facts; closed-end shares are not redeemed by the fund at NAV, and open-end shares do not trade on an exchange at a board-set price.
- C. Incorrect. Closed-end funds routinely trade at premiums or discounts to NAV with no mechanism that eliminates them; only open-end funds transact at NAV.
- D. Incorrect. This reverses which fund type has a fixed share count; closed-end funds have a fixed number of shares, not open-end funds.