Question

Which statements are TRUE when comparing an index mutual fund to an index exchange traded fund?

I) Mutual funds can be purchased on margin; exchange traded funds cannot be purchased on margin
II) Mutual funds cannot be purchased on margin; exchange traded funds can be purchased on margin
III) Mutual funds can be sold short; exchange traded funds cannot be sold short
IV) Mutual funds cannot be sold short; exchange traded funds can be sold short

A) I and III only
B) I and IV only
C) II and III only
D) II and IV only

Answer 1

The true statements when comparing an index mutual fund to an index ETF are that mutual funds cannot be purchased on margin nor sold short, whereas ETFs can be both purchased on margin and sold short. Therefore, correct option is D.

Step-by-step explanation:

When comparing an index mutual fund to an index exchange-traded fund (ETF), there are distinct features related to purchasing on margin and the ability to sell short.

Statement II is correct in that mutual funds cannot be purchased on margin, while ETFs can indeed be purchased on margin.

Statement IV is also accurate in stating that mutual funds cannot be sold short, but ETFs can be sold short because they trade like stocks on an exchange.

The key characteristics to remember are that ETFs offer the flexibility to be bought on margin and to be sold short, while mutual funds, being bought at the end of the day at the net asset value, do not provide these features.

Both types of funds are designed to offer a high rate of return over time while being subject to risks; however, the risks and returns for an individual mutual fund are typically lower than those for an individual stock. Furthermore, when an index mutual fund is traded frequently, the liquidity can be quite high.