Canadian Securities Course (CSC) Level 2 Practice Exam

Which risk involves extending the loan of stocks for a fee to earn additional income in the ETF context?

1. Concentration risk

2. Security lending risk

3. Tracking error risk

4. Currency hedging risk

The correct answer is: Security lending risk

The correct choice is indeed related to security lending risk. In the context of exchange-traded funds (ETFs), security lending refers to the practice where ETF managers lend out securities that are part of their portfolio to other financial institutions or investors, often for a fee. This process helps generate additional income for the ETF, which can benefit the fund's overall performance and provide returns to investors. Security lending risk arises because while this practice can enhance income, it also involves the risk that the borrower may not return the borrowed securities, potentially impacting the ETF's value. Moreover, the manager may face counterparty risk if the borrower encounters financial difficulties. Concentration risk, tracking error risk, and currency hedging risk pertain to different aspects of investment management and market exposure. Concentration risk focuses on the potential loss resulting from a lack of diversification in asset holdings. Tracking error risk deals with the divergence between the ETF's performance and its benchmark index. Currency hedging risk involves the potential impact of fluctuations in currency exchange rates on investments, particularly for ETFs holding foreign securities. These factors do not directly relate to the practice of lending securities for additional income.