Canadian Securities Course (CSC) Level 2 Practice Exam

What defines Synthetic Exchange Traded Funds (ETFs) in their investment strategy?

1. High transparency

2. Use of actual index assets

3. Low counterparty risk

4. Utilization of derivatives for returns

The correct answer is: Utilization of derivatives for returns

The defining characteristic of Synthetic Exchange Traded Funds (ETFs) in their investment strategy is the utilization of derivatives for returns. Synthetic ETFs do not invest directly in the physical assets of an index; instead, they use financial instruments such as swaps or other derivatives to replicate the performance of the underlying index. This approach allows them to gain exposure to a specific market or index without actually holding the underlying securities. The use of derivatives can provide certain advantages, such as the ability to achieve better tracking of the index performance or access to markets that may be difficult to invest in directly. However, this strategy also typically involves counterparty risk since it relies on the performance and reliability of the derivatives' counterparties. Thus, while they may have some transparency in terms of their objectives, synthetic ETFs are primarily defined by their approach of utilizing derivatives.