Canadian Securities Course (CSC) Level 2 Practice Exam

Which type of Exchange Traded Funds (ETFs) uses derivatives for non-hedging purposes, but with limitations?

1. Synthetic ETFs

2. Standard ETFs

3. Active ETFs

4. Leverage ETFs

The correct answer is: Synthetic ETFs

Synthetic ETFs utilize derivatives to achieve their investment objectives, often replicating the performance of an underlying index without directly holding the securities within that index. This is typically done by using swap agreements, futures contracts, and other financial instruments. The use of derivatives allows synthetic ETFs to offer investors exposure to assets or markets that they might find difficult to access directly. While synthetic ETFs can employ derivatives for speculative or leverage purposes, they often do so with strict limitations set by regulatory guidelines to mitigate risks associated with these strategies. This structure distinguishes them from standard ETFs, which primarily hold actual assets like stocks and bonds, and from leveraged ETFs that aim to amplify exposure (and risk) through significant use of derivatives. Understanding these nuances highlights why synthetic ETFs are categorized based on their derivative usage and the constraints under which they operate, aligning with the definition and framework under which they are designed.