Investors in an Exchange Traded Fund that does not hold the actual securities to match the index it tracks are exposed to which type of risk?

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Prepare for the Qualified Financial Adviser Exam 2 with flashcards and multiple choice questions, complete with hints and explanations. Get exam-ready and increase your confidence with our comprehensive study materials!

Multiple Choice

Investors in an Exchange Traded Fund that does not hold the actual securities to match the index it tracks are exposed to which type of risk?

Explanation:
Counterparty risk. When an ETF tracks an index without holding the actual securities, it typically uses derivatives (such as swaps) to gain exposure. The investor’s return then depends on the other party in those contracts fulfilling their obligations. If the counterparty defaults or experiences problems, the ETF may not receive the promised payoff, harming investors even if the index moves as expected. This is different from inflation, liquidity, or interest rate risks, which are not specific to the fund’s reliance on a derivative to replicate the index.

Counterparty risk. When an ETF tracks an index without holding the actual securities, it typically uses derivatives (such as swaps) to gain exposure. The investor’s return then depends on the other party in those contracts fulfilling their obligations. If the counterparty defaults or experiences problems, the ETF may not receive the promised payoff, harming investors even if the index moves as expected. This is different from inflation, liquidity, or interest rate risks, which are not specific to the fund’s reliance on a derivative to replicate the index.

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