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1.
Exchange-traded notes (ETNs) and exchange-traded funds (ETFs) have a lot in common. Which one of the following statements is false?
ETNs and ETFs both hold a basket of securities in order to track the performance of an index. ETNs and ETFs both trade on exchanges; that's what the 'E' in their name stands for. They both have a create and redeem process for their shares, which allows authorized participants to exchange shares for the net asset value of the underlying index, preventing large trading spreads from opening up. They both charge a fee based on a percentage of the assets under management. However, only ETFs are funds which actually hold securities in trust for the shareholders; ETNs are the debt of the issuer, who promises to pay the return of the underlying index instead of a set interest rate.
2.
What is not a tax difference between currency exchange-traded notes and all other exchange-traded notes?
Currency ETNs have foreign withholding tax. Foreign withholding tax is based upon the jurisdiction of the ETN, not the jurisdiction of the underlying index. Currency ETNs have the same tax status as other currency investments, so capital gains and income are charged at ordinary income tax rates, and are ineligible for the lower rate for long-term capital gains on investments held for more than one year. Also, even though they do not distribute interest income to investors, the holders are still responsible for the tax on the accrued interest income (and capital gains) when they file their taxes.
3.
Investors can protect themselves from the credit risk of owning an exchange-traded note by using stop-loss orders.
False. Using a stop-loss order would address market risk, not credit risk. To address credit risk, investors should monitor the financial situation of the issuing bank.
4.
A big premium on an exchange-traded note is a good sign.
False. A big premium usually indicates that the market is uncomfortable about the health of the issuing company.
5.
How can investors protect themselves from the credit risk inherent in owning an exchange-traded note?
By monitoring the financial situation of the issuing bank, and selling out if warning signs appear. The other three options are ways to mitigate the market risk of the investment, not the credit risk.
