Face-Amount Certificate Company

Under the Investment Company Act of 1940, investment companies are divided into three classifications. Which of the following is one of them?

1. A.Open-end management companyOpen-end is a subdivision of the management company classification, not one of the three top-level classes.
2. B.Hedge fundHedge funds rely on exclusions from the Act and are not registered investment companies.
3. C.Face-amount certificate companyCorrect. Face-amount certificate companies, unit investment trusts and management companies are the three classifications.
4. D.Real estate investment trustA REIT is a tax classification under the Internal Revenue Code, not an Investment Company Act classification.

Why: The Investment Company Act of 1940 classifies investment companies as face-amount certificate companies, unit investment trusts, and management companies. Management companies are then subdivided into open-end and closed-end, and separately into diversified and non-diversified. A face-amount certificate company issues debt-like certificates promising a stated amount at a future date, and a unit investment trust holds a fixed portfolio and has no board of directors or investment adviser.

A unit investment trust (UIT) is characterized by...

1. A.Shares that trade on an exchange at a premium or discountThat is a closed-end fund characteristic.
2. B.A fixed, unmanaged portfolio with redeemable units and a termination dateCorrect — a UIT is a fixed, unmanaged basket with a set termination date.
3. C.An actively managed portfolio with no end dateThat describes an open-end or closed-end fund, not a UIT.
4. D.A pool that must distribute 90 percent of its incomeThe 90 percent rule applies to REITs, not UITs.

Why: A UIT holds a fixed, unmanaged portfolio of securities, issues redeemable units, and has a set termination date. There is no active investment manager or board making ongoing decisions.

The Investment Company Act of 1940 sorts registered investment companies into three classifications. A company that issues a certificate obligating it to pay a stated sum at a fixed future date, in exchange for either a series of periodic installment payments or one lump-sum payment, belongs to which classification?

1. A.A unit investment trust.A UIT holds a fixed, unmanaged portfolio and issues redeemable units; it promises no fixed dollar amount at a fixed date.
2. B.An open-end management company.An open-end fund issues redeemable shares priced at net asset value, which fluctuates. Nothing is guaranteed.
3. C.A closed-end management company.A closed-end fund issues a fixed number of shares that trade in the secondary market at whatever price supply and demand set.
4. D.A face-amount certificate company.Correct. The promise of a stated sum at a fixed future date in exchange for installment or lump-sum payments defines a face-amount certificate company.

Why: The 1940 Act recognizes face-amount certificate companies, unit investment trusts, and management companies, with management companies further divided into open-end and closed-end. A face-amount certificate company issues a debt-like instrument promising a fixed face amount at a stated maturity in return for installment or single payments; the holder is a creditor of the issuer rather than a proportional owner of a portfolio. The classification survives mainly as an exam point today because very few such companies remain in operation.