Capital Gain

Reinvested mutual fund distributions purchase additional shares at:

1. A.Net asset value, with no sales chargeCorrect - reinvestment is at NAV.
2. B.A premium to NAVTrading at a premium or discount to NAV is closed-end fund behavior, driven by supply and demand for a fixed pool of shares. Reinvested distributions in an open-end fund buy shares at NAV, with nothing added.
3. C.A fixed 8.5% markupThis has the relationship exactly backwards. Offering reinvestment at NAV is one of the conditions a fund must satisfy before it may charge the maximum load on new purchases, so the privilege exists precisely to spare reinvested distributions from any markup.
4. D.The public offering price plus loadThis double-counts, since the public offering price already includes the sales charge. Reinvestment does not use the offering price at all: additional shares are purchased at NAV with no load.

Why: Reinvested dividends and capital gains buy additional shares at NAV, with no sales charge.

Silvestra uses the exchange privilege to move 25,000 dollars from Ravelston Short Term Bond Fund into Ravelston Growth Fund, both in the same family, at net asset value. She is surprised to receive paperwork covering two transactions rather than one. Her representative should explain that:

1. A.The fund made an error and should have processed a single transfer of shares between the two portfolios.No error occurred. An exchange is always processed as a redemption followed by a purchase.
2. B.An exchange is processed as a redemption of the first fund and a purchase of the second, and in a taxable account the redemption leg is a reportable sale.Correct. The exchange privilege waives the sales charge but the transaction is still a redemption plus a purchase, and it is taxable.
3. C.The second document is a duplicate confirmation sent to her tax preparer as a courtesy.Both documents reflect the two legs of her own transaction, not a duplicate sent elsewhere.
4. D.Because no sales charge applied, the transaction is not reportable for tax purposes.The sales charge waiver has no bearing on taxation. The redemption leg produces gain or loss.

Why: An exchange is processed as a redemption of the first fund followed by a purchase of the second, so the confirmation reflects both legs. The exchange privilege waives a new sales charge within the family, but it does not change the mechanics: shares of the first fund are cancelled and shares of the second are issued, and in a taxable account the redemption leg is a reportable sale.

A capital gains distribution from a mutual fund is taxed to the investor as:

1. A.Ordinary incomeOrdinary income treatment applies to a fund's dividend distributions of net investment income, so this describes the other main distribution type. A capital gains distribution keeps its long-term character as it passes through to the shareholder.
2. B.A long-term gain, regardless of the investor's holding periodCorrect - the fund passes through long-term gains.
3. C.A short-term gain alwaysThe instinct is that an investor who has held the shares only a few months cannot have a long-term gain. Character is set at the fund level, and a capital gains distribution is reported as long-term no matter how briefly the shareholder has owned the fund.
4. D.Tax-freeTax-free treatment belongs to the interest a municipal bond fund distributes, and that exemption is narrow. Even in a municipal fund, gains realized on selling bonds are distributed as taxable capital gains.

Why: Fund capital gains distributions are taxed as long-term gains regardless of how long the investor has held the fund shares.

Ignatius owns Class A shares of a load fund and has elected to reinvest the annual capital gain distribution. When the distribution is paid, the additional shares he receives are priced at:

1. A.net asset value, with no sales charge added.Correct. Distributions are reinvested at NAV.
2. B.the public offering price, because he holds a load fund and every purchase carries the load.A reinvested distribution is not treated as a new retail purchase for sales charge purposes.
3. C.net asset value plus a reduced sales charge equal to half the front-end load.There is no half-load convention for reinvestment.
4. D.whatever price the fund quoted on the record date, since that is when his entitlement was fixed.Pricing follows the NAV next computed after the distribution, not a record-date price.

Why: Fund families almost universally reinvest distributions at net asset value with no sales charge, and FINRA rules on investment company sales charges treat the reinvestment of distributions at a price other than net asset value as an unfair sales charge practice. Ignatius therefore buys the new shares at NAV rather than at the public offering price, even though his original purchase carried a front-end load.