Closed-end Fund

An investor buys shares of a closed-end fund on an exchange from another investor. How much of the purchase price reaches the fund itself?

1. A.The full purchase price, because the fund issued those shares in the first place.Wrong. The fund was paid when the shares were first issued, and that transaction closed long ago.
2. B.None of it, because the money passes from one investor to another.Correct. Exchange purchases of closed-end shares are secondary market trades between two investors.
3. C.The purchase price less the broker's commission, which the fund retains.Wrong. The commission belongs to the executing firm, and none of the price reaches the fund in any case.
4. D.An amount equal to the fund's net asset value per share purchased.Wrong. Net asset value measures what the portfolio is worth; it is not a payment made to the fund.

Why: A closed-end fund raises capital once, in an offering of a fixed number of shares, and the money it received then is the money it invests. After that its shares trade among investors on an exchange, exactly like the shares of an operating company. Those trades are secondary market transactions, so the fund's asset base is untouched by them and its share price is set by supply and demand rather than by net asset value. Contrast an open-end fund, where every purchase sends new money to the fund itself.

An investor sends money to an open-end investment company and receives shares that the fund will redeem at net asset value. Those shares are:

1. A.Not a security, because the fund itself redeems the shares rather than other investors buying them.Wrong. Redeemability describes how the investor exits, and redeemable securities are expressly inside the statutory definition.
2. B.Not a security, because the investor may reclaim the money at net asset value on demand.Wrong. Liquidity is not an exemption, and a demand right does not lift an interest out of the securities laws.
3. C.A security, but only as to the portion of the portfolio invested in stocks rather than bonds.Wrong. Classification attaches to the fund share itself, never to a look-through of whatever the portfolio currently holds.
4. D.A security, because the investor holds a pooled interest whose value depends on a manager's results.Correct. Pooled money, professional management and a value that moves with portfolio results is the classic security.

Why: Investment company shares are securities in their own right, and the statutory definition names redeemable securities specifically. The investor supplies money, it is pooled with that of other shareholders, and the return depends entirely on how the adviser manages the portfolio. That is both a statutory category and a straightforward Howey fit. The result would not change for a closed-end fund; what differs there is how the investor exits, not whether the share is a security.

A closed-end fund differs from an open-end fund in that a closed-end fund...

1. A.Issues a fixed number of shares that trade at a market price which may differ from NAVCorrect — closed-end shares trade at a premium or discount to NAV.
2. B.Must be bought directly from the issuer at NAVClosed-end shares trade in the secondary market, not directly from the issuer at NAV.
3. C.Continuously issues and redeems its shares at NAVThat is an open-end fund, the opposite of closed-end.
4. D.Has no investment management teamClosed-end funds are actively managed investment companies.

Why: A closed-end fund issues a fixed number of shares that then trade in the secondary market at a price set by supply and demand, which can be above (premium) or below (discount) NAV.

A closed-end fund's shares trade on an exchange at 9 dollars while its net asset value per share is 10 dollars. An investor asks whether he can require the fund to pay him the 10 dollars. What is the answer, and why?

1. A.Yes, because an investment company must always redeem its shares at net asset value.Wrong. That obligation belongs to open-end funds, which is precisely what a closed-end fund is not.
2. B.Yes, but only once he has held the shares for a full twelve months.Wrong. No holding period converts a closed-end share into a redeemable one.
3. C.No, because net asset value is calculated only once a year for closed-end funds.Wrong. Net asset value is computed regularly, and the discount reflects market pricing rather than stale figures.
4. D.No, because closed-end shares are sold to other investors at market prices.Correct. With no redemption right, the only exit is a secondary market sale at whatever buyers will pay.

Why: An open-end fund stands ready to redeem shares at net asset value, which is why its price cannot drift away from that figure. A closed-end fund carries no redemption obligation, so its shares trade on an exchange at prices set by supply and demand, and those prices can sit above or below net asset value for long stretches. The investor's only exit is to sell to another investor at the market price. That structural difference is also what allows closed-end funds to hold illiquid assets an open-end fund could not comfortably own.