How do you explain derivatives on ETF cause credit risk? ------------------------------------ Which of the following risks are specific to exchange traded funds (ETFs) that are allowed to purchase derivatives? A) Market risk. B) Trading risk. C) Credit risk. D) Tracking error risk. Your answer: B was incorrect. The correct answer was C) Credit risk. All ETFs are subject to market risk just like any other diversified portfolio. Trading risk may occur with ETFs due to impediments in the market, such as low trading volume and low liquidity in the secondary market. Tracking error risk is always present in an index fund. Only those ETFs that utilize a derivatives strategy will be subject to credit risk.
Because derivatives can introduce counterparties which introduce credit risk.
forward contracts…
I never knew that ETF portfolio can contain derivatives.