A client is considering an initial investment of $50,000 into a mutual fund and expects to hold the investment for approximately 8 years. The fund offers Class A and Class B shares with the following characteristics:
* **Class A:** 5.0% front-end sales charge, 0.25% annual 12b-1 fee.
* **Class B:** No front-end sales charge, a Contingent Deferred Sales Charge (CDSC) that declines over 5 years (e.g., 5% Year 1, 4% Year 2, etc., reaching 0% after Year 5), and a 1.00% annual 12b-1 fee for the first 6 years, after which the shares convert to Class A and the 12b-1 fee reduces to 0.25%.
Assuming no market appreciation or depreciation, which of the following represents the lowest total sales charges and 12b-1 fees incurred by the client over the 8-year holding period?
A.$3,250
B.$3,500
C.$4,000
D.$2,500
Rationale:
To determine the lowest total charges, the candidate must calculate the cumulative sales charges and 12b-1 fees for each share class over the specified 8-year holding period.
For **Class A shares**:
* Front-end sales charge: $50,000 * 0.05 = $2,500
* Annual 12b-1 fees: $50,000 * 0.0025 = $125 per year
* Total 12b-1 fees over 8 years: $125 * 8 = $1,000
* Total Class A charges: $2,500 + $1,000 = $3,500
For **Class B shares**:
* No front-end sales charge.
* No CDSC applies as the investment is held for 8 years, which is beyond the 5-year declining CDSC schedule.
* 12b-1 fees for the first 6 years: $50,000 * 0.0100 = $500 per year. Total for 6 years: $500 * 6 = $3,000.
* After 6 years, Class B shares convert to Class A shares, and the 12b-1 fee reduces to 0.25%. For the remaining 2 years (years 7 and 8): $50,000 * 0.0025 = $125 per year. Total for 2 years: $125 * 2 = $250.
* Total Class B charges: $3,000 (first 6 years) + $250 (last 2 years) = $3,250.
Comparing the totals, Class B shares ($3,250) result in lower total charges than Class A shares ($3,500) over the 8-year period. Therefore, $3,250 is the correct answer.
The option representing Class A total charges ($3,500) is incorrect because while Class A shares often become more economical over very long holding periods, in this specific scenario with the Class B conversion feature, Class B shares are slightly less expensive. The option representing Class B charges if the conversion was ignored ($4,000) is incorrect because it fails to account for the conversion of Class B shares to Class A shares after 6 years, which significantly reduces the ongoing 12b-1 fees for the remainder of the holding period. The option representing Class A's front-end load only ($2,500) is incorrect because it overlooks the additional 12b-1 fees that are incurred annually for Class A shares over the entire 8-year period.
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