A fund manager has diversified the equity portfolio he manages in order to reduce the potential negative impact of unfavorable information relating to any one stock. What type of risk has he reduced?
Answer(s): D
Unique risk, also known as firm-specific risk, is reduced through diversification, as it relates to volatility caused by information specific to individual securities. The feedback from the document states:"If a security's price is affected by new information, and if new information arrives frequently, then its price will tend to be volatile and so will the returns that it generates. This source of volatility is specific to a given security and is known as unique risk. Diversifying a portfolio reduces unique risk."
Chapter 15 Selecting a Mutual FundLearning Domain: Evaluating and Selecting MutualFunds
You are comparing the performance of ABC Equity Fund and XYZ Equity Fund to their benchmark.Indicate the correct statement.Return | Year 1 | Year 2 | Year 3 | 3 Year Compound ReturnBenchmark | -2.0% | 12.6% | 20.6% | 10.0%ABC Equity Fund | -10.0% | 16.0% | 24.0% | 9.0%XYZ Equity Fund | 8.0% | 9.0% | 10.0% | 9.0%
Answer(s): A
Fund XYZ's more consistent annual returns (less variation) reduce the likelihood of selling at a loss, especially in volatile markets. The feedback from the document states:"After finding comparable funds with good long-term performance, look for funds with the best performance from year to year. In comparing two funds, the one with less variation in simple rates of return from year to year is a more consistent performer. Although equity funds are intended for the long-term, if liquidity is needed, the fund with a more consistent performance is less likely to be sold at a loss."
Chapter 15 Selecting a Mutual FundLearning Domain: Evaluating and Selecting Mutual Funds
What type of fee does a mutual fund sponsor often reduce the longer an investor holds a back-end load fund?
Answer(s): C
Back-end load funds often have a decreasing redemption fee (deferred sales charge) schedule, which reduces the longer the investor holds the fund. The feedback from the document states:"Fund sponsors use a decreasing redemption fee (deferred sales charges) schedule to recover their costs from investors who opt out of the fund early. In most cases, redemption fees on a back-end load fund decrease the longer the investor holds the fund."
Chapter 16 Mutual Fund Fees and ServicesLearning Domain: Evaluating and Selecting Mutual Funds
Which factors would cause the management expense ratio charged by a mutual fund to be higher?The fund invests in foreign equitiesThe fund is large in sizeThe fund is managed by the fund sponsor's management teamThe fund pays a trailer fee
Factors that increase a mutual fund's management expense ratio (MER) include investing in foreign equities and paying trailer fees, as these add to operational costs. The feedback from the document states:"Four factors primarily affect the management expense ratio. Funds that invest in foreign equities; are small in size; are managed by an outside specialist firm; and charge trailer fees will have higher management expense ratios."
An investor purchases units of an equity fund for $17.60. In which of the following circumstances would an investor potentially owe taxes on capital gains?
Capital gains are realized when an investor sells a fund at a profit. Selling units at $18.80 (purchased at $17.60) triggers a taxable capital gain in a non-registered account. The feedback from the document states:"Capital gains are generated when an investor sells an investment for more than the price paid; for example, selling a stock at a profit will generate a capital gain. Capital gains are not realized when an investment goes up in price; a sale must occur."
Which exemplifies the tendency of mutual fund companies to shut down poor performing funds?
Answer(s): B
Survivorship bias occurs when poor-performing funds are closed, excluding them from performance rankings and inflating the perceived performance of surviving funds. The feedback from the document states:"All comparison universes also exhibit some degree of survivorship bias no matter how carefully the universes are constructed. Survivorship bias develops as defunct portfolios drop out and are excluded from rankings in subsequent quarters. A performance universe is essentially a universe of survivors."
Chapter 14 Understanding Mutual Fund PerformanceLearning Domain: Evaluating and Selecting Mutual Funds
Which index would investors use as a benchmark for doing research on the largest listed public companies in the US marketplace?
The S&P 500 is the appropriate benchmark for researching the largest listed public companies in the US market. The feedback from the document provides:"Index: S&P 500, Description: The 500 largest publicly held companies that trade on U.S. markets, Performance uses: U.S. equity funds."
Which Sharpe ratio result would indicate that the fund earned a return less than the risk-free return?
A negative Sharpe ratio indicates that the fund's return is less than the risk-free rate, as the numerator (Fund Return - T-bill Rate) is negative. The feedback from the document states:"The Sharpe ratio is calculated as (Fund Return - T-bill Rate) ÷ Fund Standard Deviation. A negative Sharpe ratio means the mutual fund has a return less than the risk-free rate, as the numerator of the ratio would be negative."
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