IFIC Study Guide – Chapter 13: Interpreting Key Financial
Documents
Alternative Managed Products - correct answer ✔✔-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 - correct answer ✔✔-use of complex
investment strategies, such as the use of derivatives, leveraging and principal guarantees,
skewing risk/return profiles
Principal-Protected Note (PPN) - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-commissions
-managements fees
-early redemption fees
-structuring costs and guaranteed fees
PPN Risks - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-some PPNs include an explicit
charge for structuring, and most PPNs charge a fee for providing the capital guarantee
, Implicit Costs - correct answer ✔✔-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 - correct answer ✔✔-performance averaging
formulas
-performance participation caps
-price returns vs. total returns
PPN Performance Averaging Formulas - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-individual investors with relatively small amounts to
invest can use PPNs to invest in markets they normally could not access
-can enhance the return available from cash or cash-equivalents such as GICs or T-bills
Documents
Alternative Managed Products - correct answer ✔✔-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 - correct answer ✔✔-use of complex
investment strategies, such as the use of derivatives, leveraging and principal guarantees,
skewing risk/return profiles
Principal-Protected Note (PPN) - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-commissions
-managements fees
-early redemption fees
-structuring costs and guaranteed fees
PPN Risks - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-some PPNs include an explicit
charge for structuring, and most PPNs charge a fee for providing the capital guarantee
, Implicit Costs - correct answer ✔✔-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 - correct answer ✔✔-performance averaging
formulas
-performance participation caps
-price returns vs. total returns
PPN Performance Averaging Formulas - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-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 - correct answer ✔✔-individual investors with relatively small amounts to
invest can use PPNs to invest in markets they normally could not access
-can enhance the return available from cash or cash-equivalents such as GICs or T-bills
