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ETFs 112: What to Know about Exchange-Traded Notes

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1.
A large premium on an existing exchange-traded note might do what if new shares of the note are issued?
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Fall. Large premiums can quickly collapse upon the issuance of new shares of an exchange-traded note.
2.
When it comes to earning money on them, exchange-traded notes promise investors _______.
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The return on a given index minus fees. ETNs follow a given index and promise returns based on that. They do not guarantee that return, however.
3.
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.
4.
Investors can protect themselves from the credit risk of owning an exchange-traded note by using stop-loss orders.
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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.
5.
What is not a tax difference between currency exchange-traded notes and all other exchange-traded notes?
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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.