Study guide
6.3 Exchange-Traded Funds (ETFs)
Series 65 Uniform Investment Adviser Law
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1 Introduction
About the Series 65 How to Use This Guide
2 Chapter 1: Economic Factors & Business Cycles
1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors
3 Chapter 2: Financial Reporting & Analytical Methods
2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics
4 Chapter 3: Types of Risk
3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory
5 Chapter 4: Cash Equivalents & Fixed Income Securities
4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields
6 Chapter 5: Equity Securities
5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities
7 Chapter 6: Pooled Investments
6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity
8 Chapter 7: Derivatives, Alternative Investments & Insurance Products
7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products
9 Chapter 8: Client Types & Profiles
8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer
10 Chapter 9: Portfolio Theory & Capital Markets
9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation
11 Chapter 10: Portfolio Management Strategies
10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations
12 Chapter 11: Tax Considerations & Retirement Planning
11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs
13 Chapter 12: ERISA, Special Accounts & Performance Measures
12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations
14 Chapter 13: Regulation of Investment Advisers
13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers
15 Chapter 14: Regulation of Investment Adviser Representatives
14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers
16 Chapter 15: Regulation of Broker-Dealers & Agents
15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest
17 Chapter 16: Securities Registration & Exemptions
16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions
18 Chapter 17: Communications & Client Relationships
17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations
19 Chapter 18: Ethics & Fiduciary Obligations
18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs
6.3 Exchange-Traded Funds (ETFs)
Key Takeaways Explain This Topic AI
ETFs trade intraday at market prices that can differ from NAV.
Authorized participants create and redeem shares to keep prices near NAV.
In-kind redemptions make ETFs more tax-efficient than mutual funds.
ETFs generally have lower expense ratios than active mutual funds.
Leveraged and inverse ETFs reset daily and are not for long-term holding.
ETFs can be sold short and bought on margin.
Last updated: December 2025
ETFs combine features of mutual funds and individual stocks. They offer diversification like mutual funds but trade on exchanges throughout the day like stocks. ETFs have grown dramatically in popularity due to their low costs, tax efficiency, and trading flexibility.
- ETF Characteristics
- Trading Features
- Feature ETFs Mutual Funds
- Trading Throughout the day on exchanges Once daily at NAV
- Pricing Market price (may differ from NAV) NAV only
- Order Types Market, limit, stop, stop-limit Market order only
- Short Selling Allowed Not allowed
- Margin Trading Allowed Not allowed
- Minimum Investment Price of 1 share May have minimums ($1,000+)
- Structure
Most ETFs are registered as either:
- Open-end management companies (most common)
- Unit investment trusts (older ETFs like SPDR S&P 500)
ETFs hold a basket of securities (stocks, bonds, commodities) and issue shares representing ownership in that basket.
The Creation/Redemption Mechanism
ETFs use a unique process involving Authorized Participants (APs) that keeps prices close to NAV and provides tax efficiency.
How It Works
Creation Process :
- AP assembles basket of underlying securities
- AP delivers securities to ETF sponsor
- ETF sponsor issues new ETF shares to AP
- AP sells ETF shares on exchange
Redemption Process :
- AP purchases ETF shares on exchange
- AP delivers ETF shares to ETF sponsor
- ETF sponsor delivers underlying securities to AP
- AP sells securities in the market
- Authorized Participants
- Characteristic Description
- Who They Are Large institutional investors (banks, broker-dealers)
- Role Create and redeem ETF shares with fund sponsor
- Arbitrage Keep ETF price close to NAV through creation/redemption
- Limited Number Only registered APs can transact directly with the fund
- In Practice
If an ETF trades at a premium to NAV, APs can profit by:
- Creating new ETF shares (deliver cheap basket, receive expensive ETF shares)
- Selling ETF shares on exchange
- This creation increases supply and pushes ETF price down toward NAV
- ETF Tax Efficiency
ETFs are generally more tax-efficient than mutual funds due to the in-kind creation/redemption process.
Why ETFs Are Tax-Efficient
- Factor ETF Advantage
- In-Kind Redemptions Securities transferred out, not sold—no taxable event
- No Forced Selling When investors sell ETF shares, fund doesn't sell holdings
- Tax Lot Management Can transfer out highest-cost-basis shares
- Lower Turnover Most ETFs passively track indexes
- Mutual Fund Tax Disadvantage
When mutual fund investors redeem shares:
- Fund must sell securities to raise cash
- Selling triggers capital gains
- ALL shareholders receive taxable distribution
- Even investors who didn't redeem owe taxes
- On the Exam
The key to ETF tax efficiency is the in-kind creation/redemption process . When an AP redeems ETF shares, they receive the actual securities—not cash. Since no securities are sold, no capital gains are realized.
- Types of ETFs
- Index ETFs (Most Common)
- Type What It Tracks Examples
- Broad Market Total stock market VTI, ITOT
- Large-Cap S&P 500, large companies SPY, IVV, VOO
- Small-Cap Russell 2000, small companies IWM, VB
- International Foreign developed markets EFA, VEA
- Emerging Markets Developing economies EEM, VWO
- Bond Fixed-income indexes AGG, BND
- Sector and Industry ETFs
Focus on specific sectors with higher concentration risk:
- Technology (XLK, VGT)
- Healthcare (XLV, VHT)
- Financials (XLF, VFH)
- Energy (XLE, VDE)
- Specialty ETFs
- Type Characteristics Risks
- Inverse ETFs Move opposite to index Daily reset; not for long-term
- Leveraged ETFs 2x or 3x daily returns Compounding decay; very high risk
- Commodity ETFs Track commodity prices Contango, roll costs
- Currency ETFs Track foreign currency values Currency fluctuation
- Leveraged and Inverse ETFs
These products require special understanding due to their unique risks.
Daily Reset Problem
Leveraged and inverse ETFs reset daily, which causes compounding decay over longer holding periods.
Example: 2x Leveraged ETF Over 2 Days
- Day Index Return 2x ETF Return Index Value 2x ETF Value
- Start — — $100 $100
- Day 1 +10% +20% $110 $120
- Day 2 -9.09% -18.18% $100 $98.18
The index returned to $100 (0% total), but the 2x ETF lost $1.82 (−1.82%)!
Suitability Concerns
- Suitable For NOT Suitable For
- Short-term traders Long-term investors
- Sophisticated investors Buy-and-hold strategies
- Hedging strategies Retirement accounts
- Day trading Uninformed investors
- On the Exam
Leveraged and inverse ETFs are designed for short-term trading only . Due to daily resetting and compounding effects, holding them long-term can result in significant deviation from expected returns.
ETFs vs. Mutual Funds: Complete Comparison
- Feature ETFs Mutual Funds
- Trading Intraday End of day
- Pricing Market price NAV
- Expense Ratios Generally lower Generally higher
- Tax Efficiency More efficient Less efficient
- Minimum Investment 1 share Often $1,000+
- Sales Loads None May have loads
- Commissions May pay commission None (direct purchase)
- Automatic Investing Less convenient Easy systematic investing
- Dividend Reinvestment May pay commission Usually automatic/free
- Key Takeaways
- ETFs trade on exchanges throughout the day at market prices that may differ from NAV
- Authorized Participants create and redeem ETF shares, keeping prices close to NAV
- In-kind redemptions make ETFs more tax-efficient than mutual funds
- ETFs generally have lower expense ratios than actively managed mutual funds
- Leveraged and inverse ETFs reset daily and are NOT suitable for long-term holding
- ETFs can be sold short and bought on margin , unlike mutual funds