Canadian Securities Course (CSC) Level 2 Practice Exam

What risk is associated with active Exchange Traded Funds (ETFs) due to their valuation frequency?

1. Lower transparency

2. High market exposure

3. Discrepancy risk

4. Increased tax liabilities

The correct answer is: Discrepancy risk

The correct answer highlights the potential for discrepancy risk in active Exchange Traded Funds (ETFs) due to their valuation frequency. This risk arises because actively managed ETFs may trade securities throughout the trading day in reaction to market conditions or the manager's strategies, leading to a possibility that the price at which the ETF is traded does not accurately reflect the underlying net asset value (NAV) of the assets held within it. If the valuations of these underlying assets are updated less frequently than the trading of the ETF shares, it can create a gap or discrepancy between the market price of the ETF shares and the actual value of the securities it holds. This kind of risk is particularly significant for active ETFs that may change their holdings more frequently based on investment strategies, making it essential for investors to be aware of the timing and nature of asset valuations in these products. Understanding this risk can help investors make more informed decisions about their investments in active ETFs.