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ETFs 112: What to Know about Exchange-Traded Notes

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1.
Exchange-traded notes are similar to traditional exchange-traded funds. Therefore, they are funds.
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False. They are essentially bonds, not funds. They do not hold a fundful of securities.
2.
How can investors protect themselves from the credit risk inherent in owning an exchange-traded note?
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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.
3.
A big premium on an exchange-traded note is a good sign.
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False. A big premium usually indicates that the market is uncomfortable about the health of the issuing company.
4.
What is the main tax advantage of exchange-traded notes over exchange-traded funds?
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Taxes are charged only on capital gains when the ETN is sold. ETNs are not tax-free, but they can be used to defer taxes as typically dividend or interest income is applied as an increase in the principal, so investors only have to pay taxes upon sale. At that time, the typically lower capital gains rate will be applied, not the ordinary income rate, and if the ETN was held for longer than a year, the lower long-term rate will be applied. The exception is with currency ETNs, which are taxed like other currency investments including ETFs.
5.
Distributions from exchange-traded notes are taxed at _______.
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Ordinary income rates. Distributions, though rare, are taxed at ordinary income rates.