A Canadian investment advisor is evaluating two ETFs that track the S&P 500 index. ETF A is unhedged, while ETF B is currency-hedged to the Canadian dollar. If the Canadian dollar significantly strengthens against the US dollar over the next year, how would this likely impact the CAD-denominated returns of these ETFs, assuming both underlying indices perform identically?

Question: A Canadian investment advisor is evaluating two ETFs that track the S&P 500 index. ETF A is unhedged, while ETF B is currency-hedged to the Canadian dollar. If the Canadian dollar significantly strengthens against the US dollar over the next year, how would this likely impact the CAD-denominated returns of these ETFs, assuming both underlying indices perform identically?

Answer options:

• ETF A would outperform ETF B. ✅ ETF B would outperform ETF A.
• Both ETFs would perform identically.
• Both ETFs would experience negative returns.

Correct answer: ETF B would outperform ETF A.

Explanation: If the Canadian dollar strengthens, it means that for every CAD, you can buy more USD. This negatively impacts unhedged US dollar assets when converted back to CAD. A currency-hedged ETF (ETF B) would protect against this adverse currency movement, thus outperforming the unhedged ETF (ETF A) in a strengthening CAD environment.