Exchange-Traded Funds: Mechanics and Applications

Correct Answer: ETFs provide a convenient and cost-effective way to gain exposure to commodities without the need for direct ownership and storage.

ETFs that invest in physical commodities, such as gold or silver, offer a convenient and cost-effective way for investors to gain exposure to these assets without the need for direct ownership and storage. This is the main advantage of using such ETFs. The other answers, while true, do not represent the main advantage of using physically-backed commodity ETFs: Higher liquidity compared to futures-based ETFs is a benefit, but not the primary reason investors choose physically-backed ETFs. Lower tracking error relative to the spot price is also a positive aspect, but it is not the main advantage that attracts investors to these products.

Correct Answer: They can help mitigate the impact of foreign exchange rate fluctuations on portfolio returns

The correct answer is that currency-hedged ETFs can help mitigate the impact of foreign exchange rate fluctuations on portfolio returns. When investing in international equities, investors are exposed to both the performance of the underlying stocks and the fluctuations in foreign exchange rates. Currency-hedged ETFs use derivatives to hedge the currency risk, aiming to isolate the returns of the underlying equities. The other options are incorrect because: - Currency-hedged ETFs do not provide a guaranteed return independent of equity market movements and currency fluctuations. They still carry the risk of the underlying equity investments. - Currency-hedged ETFs do not necessarily offer higher returns compared to unhedged ETFs. By hedging the currency risk, they aim to provide returns that more closely track the performance of the underlying equities, rather than seeking to enhance returns through currency exposure.

Correct Answer: ETFs can be bought and sold throughout the trading day at market-determined prices, providing greater liquidity and flexibility.

ETFs can be bought and sold throughout the trading day at market-determined prices, providing greater liquidity and flexibility. This is a key advantage compared to traditional mutual funds, which can only be bought or sold at the end of each trading day at the fund's net asset value (NAV).

The other answers are incorrect:

ETFs typically have lower expense ratios than actively managed mutual funds because they are passively managed and aim to track an index. Active management and frequent trading usually lead to higher costs for mutual funds, not ETFs.

ETFs can be just as diversified as traditional mutual funds. While some ETFs focus on specific sectors or industries, many ETFs track broad market indices and offer significant diversification.