CSC Mutual Funds and ETFs 5 — Questions and Answers
Question 1: A balanced mutual fund typically allocates assets between which two major asset classes?
- Real estate and commodities
- Equities and fixed income securities (Correct answer)
- Domestic and foreign equities only
- Cash and derivatives
Correct answer: Equities and fixed income securities
Balanced funds blend equities for growth and fixed income for income and stability, aiming to offer a middle ground between pure equity and bond funds.
Question 2: When a mutual fund distributes a return of capital (ROC), what is the immediate tax consequence for a Canadian investor?
- It is taxed as ordinary income
- It is not immediately taxable but reduces the investor's adjusted cost base (Correct answer)
- It is taxed as a capital gain
- It is taxed as a dividend
Correct answer: It is not immediately taxable but reduces the investor's adjusted cost base
ROC distributions reduce the investor's adjusted cost base rather than being immediately taxable, deferring taxation until the units are sold.
Question 3: Which ETF replication method holds all (or a representative sample of) the actual securities in an index?
- Synthetic replication
- Physical replication (Correct answer)
- Derivative replication
- Notional replication
Correct answer: Physical replication
Physical replication means the ETF directly holds the underlying securities of the index, either all of them (full replication) or a representative sample (sampling).
Question 4: What is a 'clone fund' in the context of Canadian mutual funds?
- A fund that copies another fund's entire portfolio
- A Canadian fund that mirrors a foreign fund using derivatives to gain foreign exposure within RRSP rules (Correct answer)
- A fund managed by the same team as another fund
- A fund that duplicates index returns
Correct answer: A Canadian fund that mirrors a foreign fund using derivatives to gain foreign exposure within RRSP rules
Clone funds used derivatives to replicate foreign fund returns within a Canadian registered plan, historically used before the foreign content limits for RRSPs were eliminated.
Question 5: Under CSC principles, what does 'dollar-cost averaging' through regular mutual fund purchases achieve for investors?
- Always buying at the lowest possible price
- Reducing the average cost per unit by buying more units when prices are low and fewer when prices are high (Correct answer)
- Guaranteeing positive returns over time
- Eliminating market risk entirely
Correct answer: Reducing the average cost per unit by buying more units when prices are low and fewer when prices are high
Dollar-cost averaging means investing fixed amounts regularly, automatically purchasing more units when prices fall and fewer when prices rise, potentially lowering average cost.
Question 6: Which of the following best describes a 'currency-hedged' ETF?
- An ETF that only invests in Canadian dollar assets
- An ETF that uses forward contracts or other derivatives to neutralize foreign exchange fluctuations on foreign holdings (Correct answer)
- An ETF that invests only in currency pairs
- An ETF with no exposure to international markets
Correct answer: An ETF that uses forward contracts or other derivatives to neutralize foreign exchange fluctuations on foreign holdings
Currency-hedged ETFs use forward contracts or swaps to offset foreign exchange movements, so returns reflect only the underlying foreign asset performance, not currency shifts.
Question 7: What is the primary purpose of the 'right of rescission' available to Canadian mutual fund purchasers?
- To switch between fund companies without fees
- To cancel a mutual fund purchase within two days if the Fund Facts document was not delivered before the trade (Correct answer)
- To redeem units at a guaranteed price
- To request a refund of the MER
Correct answer: To cancel a mutual fund purchase within two days if the Fund Facts document was not delivered before the trade
Canadian securities law grants investors the right to rescind (cancel) a mutual fund purchase within two business days if proper Fund Facts disclosure was not provided before the trade.
CSC Mutual Funds and ETFs 5
A balanced mutual fund typically allocates assets between which two major asset classes?