IFC Products and Trading 3 — Questions and Answers
Question 1: Under Canadian securities regulation, what is a 'principal-protected note' (PPN)?
- A structured product that guarantees return of principal at maturity (Correct answer)
- A government bond with a floating coupon
- A money market instrument issued by Schedule A banks
- A type of ETF with built-in downside protection
Correct answer: A structured product that guarantees return of principal at maturity
A PPN is a structured product that guarantees the investor will receive at least the original principal back at maturity, while providing exposure to an underlying asset.
Question 2: Which order type guarantees execution but not price when trading an ETF?
- Market order (Correct answer)
- Limit order
- Stop-limit order
- Good-till-cancelled order
Correct answer: Market order
A market order guarantees execution at the best available price but does not guarantee a specific price, unlike a limit order.
Question 3: What distinguishes a 'labour-sponsored investment fund' (LSIF) from a conventional mutual fund?
- LSIFs invest in small- and medium-sized businesses and offer tax credits (Correct answer)
- LSIFs are exempt from all provincial securities regulation
- LSIFs guarantee a minimum annual return to investors
- LSIFs trade on the Toronto Stock Exchange
Correct answer: LSIFs invest in small- and medium-sized businesses and offer tax credits
LSIFs are venture capital funds sponsored by labour organizations that invest in SMEs and provide investors with federal and provincial tax credits.
Question 4: A mutual fund's management expense ratio (MER) does NOT typically include:
- Brokerage commissions paid on portfolio trades (Correct answer)
- Management fees paid to the fund manager
- Operating expenses of the fund
- Applicable taxes on management fees
Correct answer: Brokerage commissions paid on portfolio trades
Portfolio trading commissions are generally excluded from the MER and are instead reported separately as part of the trading expense ratio (TER).
Question 5: Which of the following best describes the creation/redemption mechanism unique to ETFs?
- Designated brokers exchange baskets of securities for ETF units with the fund (Correct answer)
- Retail investors submit creation orders directly to the ETF manager
- ETF units are created only when the fund launches
- New ETF units are created when NAV exceeds market price by 5%
Correct answer: Designated brokers exchange baskets of securities for ETF units with the fund
Designated brokers (market makers) create or redeem large blocks of ETF units by exchanging the underlying basket of securities with the ETF manager, keeping market price close to NAV.
Question 6: What is 'tracking error' in the context of index-based investment products?
- The deviation between a fund's return and its benchmark index return (Correct answer)
- An error in calculating the fund's NAV
- The difference between bid and ask price for an ETF
- A regulatory violation in portfolio rebalancing
Correct answer: The deviation between a fund's return and its benchmark index return
Tracking error measures how closely a fund replicates its benchmark, with higher values indicating greater divergence from index performance.
Question 7: Which factor would most likely cause an ETF to trade at a discount to its NAV?
- Selling pressure and low liquidity in the underlying securities (Correct answer)
- Higher-than-average daily trading volume for the ETF
- An increase in the benchmark index value
- A stock split of a major constituent holding
Correct answer: Selling pressure and low liquidity in the underlying securities
When investors sell an ETF heavily and the underlying market is illiquid, market price can fall below NAV, creating a discount.
IFC Products and Trading 3
Under Canadian securities regulation, what is a 'principal-protected note' (PPN)?