IFIC CHAPTER 13 QUESTIONS WITH
COMPLETE SOLUTION
uAlternative Managed Products - -professionally managed portfolios of basic asset classes and/or
commodities and include segregated funds, hedge funds, alternative mutual funds, exchange-traded
funds, closed-end funds and principal-protected notes (PPN)
What Distinguishes Alternative Managed Products - -use of complex investment strategies, such as the
use of derivatives, leveraging and principal guarantees, skewing risk/return profiles
Principal-Protected Note (PPN) - -a debt instrument. Like other debt instruments, a PPN has a maturity
date upon which the issuer agrees to repay investors their principal. In addition to the principal, PPNs
provide interest paid either at maturity or as regular payments linked to the positive performance of the
underlying PPN asset.
-the underlying assets can be common stocks, indexes, mutual funds, exchange-traded funds,
commodities or hedge funds
-issued only by the 6 major banks
-these products are not mutual funds; as a result, they are not held to the transparency standards of
mutual funds
-the PPN doesn't have a guaranteed return, while a simple GIC does.
Banks 3 Main Roles In PPNs - -issuers- the banks guarantee the return of principal at maturity. The value
of the guarantee is based wholly on the perceived creditworthiness of the issuer.
-manufacturers- they choose the underlying asset, the term to maturity, and any special features tied to
interest payments.
-distribute- primarily through their investment dealer arm, although some banks use a third-party
investment dealer or mutual fund dealer
Explicit Costs Of Principal-Protected Notes - -commissions
-managements fees
-early redemption fees
-structuring costs and guaranteed fees
PPN Risks - -lack of transparency
-lack of knowledge regarding suitability
-not protected by CIDC
, -not issued under a prospectus
-risks also include market, liquidity, credit and, currency
PPN Commissions - -PPNs differ from mutual funds in that investors bear the cost of the commission at
the time of purchase because the net asset value (NAV) of the PPN declines directly as a result of
commissions paid.
PPN Management Fees - -many PPNs carry a management fee for actively managing the PPN's assets.
Some PPNs, however, are issued without management fees. When a management fee is charged it is
charged to the assets of the PPN. Management fees affect the PPN's performance, which in turn affects
the final payoff received by investors.
PPN Early Redemption Fees - -many PPNs carry an early redemption fee or deferred sales charge. A
typical early redemption fee schedule runs from two to five years and declines over time, as with a
mutual fund. The purpose of the early redemption fee is to ensure that the PPN's issuer receives the full
fees it was expecting.
PPN Structuring Costs and Guarantee Fees - -some PPNs include an explicit charge for structuring, and
most PPNs charge a fee for providing the capital guarantee
Implicit Costs - -fees borne by investors that may or may not be immediately visible and that may or may
not be openly disclosed in the documents
Implicit Costs Of Principal-Protected Notes - -performance averaging formulas
-performance participation caps
-price returns vs. total returns
PPN Performance Averaging Formulas - -many mutual fund-based and income-producing PPNs use
performance averaging formulas in which the PPN's final payoff is based not on the value of the
underlying asset at maturity, but on some average performance of the underlying asset over the life of
the note. This average performance typically is based on the note's monthly average NAV and may raise
or lower the return to investors.
PPN Performance Participation Caps - -a PPN with a performance participation cap promises to pay the
return earned by some particular asset up to a maximum amount.
-ex: an index-linked GIC might pay 60% of the return of the S&P/TSX 60 Index while guaranteeing
investment principal. If the performance of the underlying asset exceeds the cap, investors would incur
an opportunity cost because they could have earned a higher return on the investment if the cap did not
exist.
PPN Price Returns vs. Total Returns - -the final payoff is based on the underlying asset's price return
rather than its total return. Total return refers to the change in price plus any income such as dividends
or interest. Using price return rather than total return is a hidden cost because it underestimates the
actual performance of the underlying asset.
PPN Advantages - -individual investors with relatively small amounts to invest can use PPNs to invest in
markets they normally could not access
COMPLETE SOLUTION
uAlternative Managed Products - -professionally managed portfolios of basic asset classes and/or
commodities and include segregated funds, hedge funds, alternative mutual funds, exchange-traded
funds, closed-end funds and principal-protected notes (PPN)
What Distinguishes Alternative Managed Products - -use of complex investment strategies, such as the
use of derivatives, leveraging and principal guarantees, skewing risk/return profiles
Principal-Protected Note (PPN) - -a debt instrument. Like other debt instruments, a PPN has a maturity
date upon which the issuer agrees to repay investors their principal. In addition to the principal, PPNs
provide interest paid either at maturity or as regular payments linked to the positive performance of the
underlying PPN asset.
-the underlying assets can be common stocks, indexes, mutual funds, exchange-traded funds,
commodities or hedge funds
-issued only by the 6 major banks
-these products are not mutual funds; as a result, they are not held to the transparency standards of
mutual funds
-the PPN doesn't have a guaranteed return, while a simple GIC does.
Banks 3 Main Roles In PPNs - -issuers- the banks guarantee the return of principal at maturity. The value
of the guarantee is based wholly on the perceived creditworthiness of the issuer.
-manufacturers- they choose the underlying asset, the term to maturity, and any special features tied to
interest payments.
-distribute- primarily through their investment dealer arm, although some banks use a third-party
investment dealer or mutual fund dealer
Explicit Costs Of Principal-Protected Notes - -commissions
-managements fees
-early redemption fees
-structuring costs and guaranteed fees
PPN Risks - -lack of transparency
-lack of knowledge regarding suitability
-not protected by CIDC
, -not issued under a prospectus
-risks also include market, liquidity, credit and, currency
PPN Commissions - -PPNs differ from mutual funds in that investors bear the cost of the commission at
the time of purchase because the net asset value (NAV) of the PPN declines directly as a result of
commissions paid.
PPN Management Fees - -many PPNs carry a management fee for actively managing the PPN's assets.
Some PPNs, however, are issued without management fees. When a management fee is charged it is
charged to the assets of the PPN. Management fees affect the PPN's performance, which in turn affects
the final payoff received by investors.
PPN Early Redemption Fees - -many PPNs carry an early redemption fee or deferred sales charge. A
typical early redemption fee schedule runs from two to five years and declines over time, as with a
mutual fund. The purpose of the early redemption fee is to ensure that the PPN's issuer receives the full
fees it was expecting.
PPN Structuring Costs and Guarantee Fees - -some PPNs include an explicit charge for structuring, and
most PPNs charge a fee for providing the capital guarantee
Implicit Costs - -fees borne by investors that may or may not be immediately visible and that may or may
not be openly disclosed in the documents
Implicit Costs Of Principal-Protected Notes - -performance averaging formulas
-performance participation caps
-price returns vs. total returns
PPN Performance Averaging Formulas - -many mutual fund-based and income-producing PPNs use
performance averaging formulas in which the PPN's final payoff is based not on the value of the
underlying asset at maturity, but on some average performance of the underlying asset over the life of
the note. This average performance typically is based on the note's monthly average NAV and may raise
or lower the return to investors.
PPN Performance Participation Caps - -a PPN with a performance participation cap promises to pay the
return earned by some particular asset up to a maximum amount.
-ex: an index-linked GIC might pay 60% of the return of the S&P/TSX 60 Index while guaranteeing
investment principal. If the performance of the underlying asset exceeds the cap, investors would incur
an opportunity cost because they could have earned a higher return on the investment if the cap did not
exist.
PPN Price Returns vs. Total Returns - -the final payoff is based on the underlying asset's price return
rather than its total return. Total return refers to the change in price plus any income such as dividends
or interest. Using price return rather than total return is a hidden cost because it underestimates the
actual performance of the underlying asset.
PPN Advantages - -individual investors with relatively small amounts to invest can use PPNs to invest in
markets they normally could not access
