How does Leverage Impact Risk and Investment Returns?

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Leveraged ETFs allow investors to amplify the amount of exposure that they can obtain with each dollar of investment. In the case of a 2X Bull Fund, each dollar invested offers $2 worth of exposure to the benchmark index. It is important to understand, however, that although the investor cannot lose more than their principal investment, their market risk is two times greater than their principal investment.

See the following examples of Investor A and Investor B. These hypothetical examples do not reflect the impact of expenses such as commission charges which would lower the results shown.

To clearly understand the impact that leverage has on an ETF in terms of both investment returns as well as market risk, we will review the following four market movement examples.

Bull Fund Examples

• 2X Bull Fund when the index rises

• 2X Bull Fund when the index declines

Bear Fund Examples

• 2X Bear Fund when the index rises

• 2X Bear Fund when the index declines

Scenario #1: Investment in a 2X Bull Fund and Index Increases

What happens to an investment in a 2X Bull Fund when the benchmark index moves in favor of the fund (increases)?

The daily return of the investment in this scenario would be a gain of $1,000. This can be thought of as 2X the daily increase in the index (10%) multiplied by the amount of the initial investment of $10,000, or the daily index return (5%) multiplied by the total market exposure of $20,000.

It is important to note that the return of the investment over the day is equal to 5% of the total exposure and market risk levels, not a 5% return of the principal invested.

Scenario #2: Investment in a 2X Bull Fund and Index Declines

What happens to an investment in a 2X Bull Fund when the benchmark index moves against the fund (decreases)?

The daily return of the investment in this scenario would be a loss of $1,000. This can be thought of as 2X the daily decrease in the index (-10%) multiplied by the amount of the initial investment of $10,000, or the daily index return (-5%) multiplied by the total market exposure of $20,000.

The loss on the investment in this scenario would be $1,000, which is 2x the daily decrease in the index (-10%) multiplied by the amount of the total initial investment.

Scenario #3: Investment in a 2X Bear Fund and Index Increases

What happens to an investment in a 2X Bear Fund when the benchmark index moves against the fund (increases)?

The daily return of the investment in this scenario would be a loss of $1,000. This can be thought of as 2X the daily increase in the index (10%) multiplied by the amount of the initial investment of $10,000, or the daily index return (5%) multiplied by the total market exposure of ($20,000).

In the case of a Bear Fund, when the index rises, the Fund will incur a loss equal to 2X the inverse of the index movement.

Scenario #4: Investment in a 2X Bear Fund and Index Declines

What happens to an investment in a 2X Bear Fund when the benchmark index moves with the fund (decreases)?

The daily return of the investment in this scenario would be a gain of $1,000. This can be thought of as 2X the daily decrease in the index (-10%) multiplied by the amount of the initial investment of $10,000, or the daily index return (-5%) multiplied by the total market exposure of ($20,000).

In the case of a Bear Fund, when the index declines, the Fund will incur a gain equal to 2X the inverse of the index movement.

*These performance numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature. There is no guarantee the funds will achieve their objective.

To sum up, the key concepts to understand about leveraged Bull and Bear Funds are:

For Bull Funds:

• Bull Fund movements work in sync with the direction of their benchmark index movements, so if an index goes up 1%, the Bull Fund's assets and exposure level increase by the fund's stated leverage point.

• If the index goes down 1%, then the fund's assets and exposure will decrease by the fund's stated leverage point.

For Bear Funds:

• There is an inverse relationship between the performance of the index and the performance of the Bear Fund.

• If an underlying index goes down, the fund will produce a positive return equal to its stated leverage point.

• If an underlying index goes up, the fund will produce a negative return equal to its stated leverage point.、