Chartered Financial Analyst (CFA) Practice Exam Level 2

What is a soft dollar arrangement?

1. Direct cash payments from clients to brokers

2. A practice where brokers offer kickbacks or incentives for trading

3. A fixed fee arrangement for trading services

4. A cash rebate on trading commissions

The correct answer is: A practice where brokers offer kickbacks or incentives for trading

A soft dollar arrangement refers to a practice where investment managers use client commissions to pay for services that assist in investment decision-making and portfolio management, rather than paying directly in cash or through fixed fees. In this context, brokers may provide research, data, or other ancillary services as part of the transactions executed on behalf of clients, which effectively acts as a form of incentive or kickback for trading. This arrangement allows asset managers to reduce their out-of-pocket costs for obtaining research and investment advice by using the commissions generated from trades, making it appealing for managing funds while fostering relationships with brokers. The key distinction of soft dollar arrangements is that they utilize commissions, which can make it complicated for clients to understand how much they are actually paying for various investment services. Other options do not accurately represent what a soft dollar arrangement entails. Direct cash payments from clients do not involve commission-based services. A fixed fee arrangement does not leverage commissions at all. Similarly, a cash rebate on trading commissions is a separate concept and does not encompass the wider range of services typically obtained through soft dollar arrangements.