CSC Mutual Funds and ETFs 2 — Questions and Answers
Question 1: Which structure allows an ETF to create or redeem units in large blocks directly with authorized participants?
- Secondary market trading
- In-kind creation/redemption mechanism (Correct answer)
- Open-end mutual fund redemption
- Closed-end fund buyback
Correct answer: In-kind creation/redemption mechanism
ETFs use an in-kind creation/redemption mechanism where authorized participants exchange baskets of securities for ETF units, keeping prices aligned with NAV.
Question 2: What is the primary tax advantage of the in-kind ETF redemption process compared to mutual funds?
- ETFs never generate capital gains
- Redemptions can be satisfied with low-cost securities, deferring embedded gains (Correct answer)
- ETFs are exempt from all Canadian taxes
- Mutual funds always distribute more income
Correct answer: Redemptions can be satisfied with low-cost securities, deferring embedded gains
In-kind redemptions allow the ETF to distribute appreciated securities rather than selling them, deferring capital gains recognition for remaining unitholders.
Question 3: A mutual fund with a 2% management expense ratio (MER) and 0.5% trading expense ratio (TER) has a total cost to investors of:
- 2.0%
- 0.5%
- 2.5% (Correct answer)
- 1.5%
Correct answer: 2.5%
The fund's total cost is the MER plus TER, which equals 2.0% + 0.5% = 2.5% annually.
Question 4: Under Canadian securities regulation, mutual fund prospectuses must be renewed every:
- 6 months
- 12 months (Correct answer)
- 24 months
- 36 months
Correct answer: 12 months
Canadian mutual fund prospectuses must be renewed annually (every 12 months) to ensure disclosure documents remain current.
Question 5: Which type of ETF uses derivatives to deliver a multiple (e.g., 2x) of an index's daily return?
- Sector ETF
- Leveraged ETF (Correct answer)
- Inverse ETF
- Currency-hedged ETF
Correct answer: Leveraged ETF
Leveraged ETFs use derivatives such as futures and swaps to amplify daily index returns by a stated multiple like 2x or 3x.
Question 6: What is 'tracking error' in the context of index ETFs?
- A pricing error on the exchange
- The divergence between the ETF's return and its benchmark index return (Correct answer)
- Incorrect NAV calculation
- A failed creation/redemption order
Correct answer: The divergence between the ETF's return and its benchmark index return
Tracking error measures how closely an ETF's performance follows its benchmark index, with higher tracking error indicating greater divergence.
Question 7: A fund-of-funds structure in Canadian mutual funds results in investors bearing:
- Lower fees due to institutional pricing
- Fees at both the underlying fund level and the top-level fund level (Correct answer)
- Only the top-level fund's MER
- No management fees on underlying funds
Correct answer: Fees at both the underlying fund level and the top-level fund level
Fund-of-funds investors pay MERs at both levels — the underlying funds' fees plus the top-level fund's management fee — leading to layered costs.
CSC Mutual Funds and ETFs 2
Which structure allows an ETF to create or redeem units in large blocks directly with authorized participants?