fund ex- penses, and periodically these arrangements come under attack. I. Introduction 4. Mutual Funds and Other Investment Companies The McGraw−Hill Companies, 2001           CHAPTER 4 Mutual Funds and Other Investment Companies 115           CONCEPT C H E C K ☞ QUESTION 2 The Equity Fund sells Class A shares with a front-end load of 4% and Class B shares with 12b-1 fees of .5% annually as well as back-end load fees that start at 5% and fall by 1% for each full year the investor holds the portfolio (until the fifth year). Assume the rate of return on the fund portfolio net of operating expenses is 10% annually. What will be the value of a $10,000 invest- ment in Class A and Class B shares if the shares are sold after (a) 1 year, (b) 4 years, (c) 10 years? Which fee structure provides higher net proceeds at the end of the investment horizon?         4.5 TAXATION OF MUTUAL FUND INCOME   Investment returns of mutual funds are granted "pass-through status" under the U.S. tax code, meaning that taxes are paid only by the investor in the mutual fund, not by the fund itself. The income is treated as passed through to the investor as long as the fund meets sev- eral requirements, most notably that at least 90% of all income is distributed to sharehold- ers. In addition, the fund must receive less than 30% of its gross income from the sale of securities held for less than three months, and the fund must satisfy some diversification criteria. Actually, the earnings pass-through requirements can be even more stringent than 90%, since to avoid a separate excise tax, a fund must distribute at least 98% of income in the calendar year that it is earned. A funds short-term capital gains, long-term capital gains, and dividends are passed through to investors as though the investor earned the income directly. The investor will pay taxes at the appropriate rate depending on the type of income as well as the investors own tax bracket.2 The pass through of investment income has one important disadvantage for individual investors. If you manage your own portfolio, you decide when to realize capital gains and losses on any security; therefore, you can time those