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RSE practice questions: borrowing-to-invest and margin

Ten RSE practice questions on borrowing-to-invest, margin, and short selling. NI 31-103 §13.13 requires written pre-trade leverage disclosure. CIRO Rule 5300 series governs margin requirements. UMIR 3.3 requires a reasonable expectation of borrow before short-sale order entry. Retail clients typically need the highest level of disclosure on these products.

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  1. 1

    Under National Instrument 81-102, which type of mutual fund organizational structure issues units of beneficial interest to investors rather than shares of a corporation?

    Outcome 5.3 · click for answer

    A.Mutual fund corporation
    B.Mutual fund trustCorrect
    C.Closed-end fund corporation
    D.Limited partnership

    Mutual fund trusts issue units; corporations issue shares.

  2. 2

    A mutual fund has total assets of $250 million, total liabilities of $5 million, and 10 million units outstanding. What is the net asset value per unit (NAVPU) of the fund?

    Outcome 5.9 · click for answer

    A.$25.00
    B.$24.50Correct
    C.$25.50
    D.$2.45

    NAVPU = (250M - 5M) / 10M = 245M / 10M = $24.50 per unit.

  3. 3

    Which of the following is a key advantage of an exchange-traded fund (ETF) compared to a traditional open-end mutual fund for a retail investor?

    Outcome 5.5 · click for answer

    A.ETFs always have higher MERs than mutual funds
    B.ETFs can be bought and sold throughout the trading day at market pricesCorrect
    C.ETFs are guaranteed by the federal government
    D.ETFs cannot be held in registered accounts

    ETFs trade intraday on exchanges; mutual funds price once daily at NAV.

  4. 4

    Under Canadian regulations, what document must be delivered to a retail mutual fund investor at or before the point of sale to satisfy disclosure requirements?

    Outcome 5.7 · click for answer

    A.The simplified prospectus only
    B.The Fund Facts documentCorrect
    C.The annual information form (AIF)
    D.The Management Report of Fund Performance (MRFP)

    Fund Facts must be delivered at or before the point of sale to retail clients.

  5. 5

    A mutual fund's management expense ratio (MER) is 2.10%. Which of the following best describes what this percentage represents to the unitholder?

    Outcome 5.10 · click for answer

    A.The annual sales commission paid to the dealer
    B.Total annual fund operating expenses as a percentage of average net assetsCorrect
    C.The fund's annualized return after fees
    D.The trailing commission paid to the advisor only

    MER measures total annual fund expenses including management fee, taxes and operating costs.

  6. 6

    Hedge funds are typically distributed under prospectus exemptions and limited to qualifying investors. Which group is most commonly eligible to invest under these exemptions?

    Outcome 5.13 · click for answer

    A.All retail investors regardless of net worth
    B.Accredited investors meeting income or asset thresholdsCorrect
    C.Only institutional investors registered with CIRO
    D.Only Canadian residents under age 65

    Hedge funds use exemptions like accredited investor under NI 45-106.

  7. 7

    Which of the following managed products trades on a stock exchange at a market price that may differ from its underlying net asset value, and does not redeem units daily?

    Outcome 5.1 · click for answer

    A.Open-end mutual fund trust
    B.Closed-end fundCorrect
    C.Pooled fund
    D.Money market mutual fund

    Closed-end funds trade on exchanges and may trade at premiums or discounts to NAV.

  8. 8

    Which of the following statements best describes a passively managed index mutual fund or ETF tracking a broad equity benchmark like the S&P/TSX Composite Index?

    Outcome 5.6 · click for answer

    A.It seeks to outperform the index using active stock selection
    B.It seeks to replicate the index's holdings and return at low costCorrect
    C.It uses leverage to multiply daily index returns
    D.It targets absolute returns regardless of market direction

    Passive index funds replicate the index to match its return at minimal cost.

  9. 9

    An investor purchases a 2x leveraged ETF designed to deliver twice the daily return of an index. Why might holding this ETF for several months produce returns that differ significantly from twice the index's cumulative return?

    Outcome 5.5 · click for answer

    A.Because of front-end load fees applied at purchase
    B.Because of daily compounding and volatility decay over timeCorrect
    C.Because the ETF has no underlying index exposure
    D.Because leveraged ETFs reset their leverage annually

    Leveraged ETFs reset daily; compounding and volatility cause path dependence.

  10. 10

    Which of the following is most accurately described as a deferred sales charge (DSC) or back-end load on a mutual fund unit purchase by a retail investor?

    Outcome 5.10 · click for answer

    A.A fee paid at purchase reducing initial investment
    B.A fee charged at redemption that declines over a holding periodCorrect
    C.An ongoing fee deducted daily from the NAV
    D.A performance fee charged when the fund beats its benchmark

    DSC is a redemption fee that typically scales down over a multi-year schedule.

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FAQ

When does §13.13 leverage disclosure apply?

Whenever a client uses borrowed funds to purchase securities. Required in writing, before the trade. Must cover risk of margin call, magnified losses, and interest cost.

What's the initial margin requirement on long equities?

Standard initial margin is typically 30% on long equity positions (with security-specific exceptions for reduced-margin eligible securities under CIRO Rule 5300). Maintenance margin is typically 25%.

What's reduced-margin eligibility?

CIRO Rule 5300 requires the security to be on the CIRO Securities List and meet criteria including a $5/share minimum price. Reduced-margin lowers the initial requirement (often to 25% from 30%).

What's the short-sale locate rule?

UMIR 3.3 requires reasonable grounds to believe the security can be borrowed before order entry. Naked short selling without locate is prohibited.

Can a retail client open a margin account by default?

No. CIRO Rule 3401 requires account-appropriateness assessment before the account is activated for margin trading. The client must demonstrate sufficient knowledge and financial capacity.

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