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

    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.$24.50Correct
    B.$25.00
    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 carry higher management expense ratios than comparable mutual funds
    B.ETF unit values are backed by a federal government guarantee program
    C.ETFs can be bought and sold throughout the trading day at market pricesCorrect
    D.ETFs are ineligible investments for RRSPs and other 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 Fund Facts document, delivered to the investor at or before the point of saleCorrect
    B.The Management Report of Fund Performance, delivered to the investor after each purchase
    C.The simplified prospectus, delivered to the investor within two days after the trade
    D.The annual information form, delivered to the investor with the year-end account statement

    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 fund's annualized return to unitholders after all fees and taxes are deducted
    B.Total annual fund operating expenses as a percentage of average net assetsCorrect
    C.The trailing commission the dealer pays to the advisor each year
    D.The upfront sales commission charged when units are purchased

    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.Only institutional investors registered with CIRO
    C.Accredited investors meeting income or asset thresholdsCorrect
    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.A closed-end fund traded on an exchange at a price that can differ from its NAVCorrect
    B.A pooled fund sold through an investment manager and priced at NAV each valuation date
    C.A money market mutual fund that redeems units daily at a constant net asset value
    D.An open-end mutual fund trust that issues and redeems units daily based on NAV

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

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

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

    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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