Closed-end mutual funds are pooled investment vehicles that raise a fixed amount of capital through an initial public offering (IPO) and then list shares for trading on a stock exchange. Unlike open-end mutual funds, closed-end funds do not continuously issue new or redeem existing shares. The price of closed-end fund shares is determined by supply and demand in the market, which may result in shares trading at a premium or discount to the net asset value (NAV) of the fund's underlying assets.
Which of the following is a key difference between closed-end funds and open-end mutual funds?
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Select an option above to see an explanation here.
A) Closed-end funds trade on stock exchanges, while open-end mutual funds do not. B) Open-end mutual funds continuously issue and redeem shares, while closed-end funds have a fixed number of shares. C) Closed-end funds have a fixed number of shares and do not continuously issue and redeem shares. D) Open-end mutual funds can pay dividends, just like closed-end funds.
What is the term for when a closed-end fund's market price is lower than its net asset value (NAV)?
A) A premium occurs when a closed-end fund's market price is higher than its NAV. B) A discount occurs when a closed-end fund's market price is lower than its NAV. C) Capital gains are increases in the value of a closed-end fund's investments. D) Dividends are payments made by a closed-end fund to its shareholders.
Which of the following investment vehicles also trades on a stock exchange but continuously issues and redeems shares?
A) Open-end mutual funds do not trade on stock exchanges and continuously issue and redeem shares at their NAV. B) Unit investment trusts (UITs) have a fixed portfolio and a set termination date but do not trade on stock exchanges. C) Hedge funds are pooled investment vehicles that use various strategies to generate returns but do not trade on stock exchanges. D) Exchange-traded funds (ETFs) trade on stock exchanges and continuously issue and redeem shares.
In the early 1900s, closed-end funds gained popularity as a way for investors to access diversified portfolios of stocks and bonds. One such fund focused on investing in railroad companies saw its share price rise significantly during rapid industry growth. However, when the market experienced a downturn, the fund's share price fell to a steep discount to its NAV, illustrating the potential risks and volatility associated with closed-end funds.
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Example Series 65 Example Practice Question
An investor looking for exposure to a specific sector, such as technology, might consider purchasing shares of a closed-end fund focusing on technology stocks. By doing so, the investor can gain access to a diversified portfolio of technology companies without researching and selecting individual stocks.