Business IX Flashcards
What is indexing?
What is the advantage of indexing?
Indexing is a type of passive investing where you invest in an index fund.
Advantages:
- it cuts down on management expense ratio
- many mutual funds fail to beat broad indexes.
Expense ratio
A measure of what it costs an investment company to operate a mutual fund (legal expenses, taxes, etc).
Marketable security
A very liquid security that can be converted into cash quickly.
ETF
Exchange Traded Fund
A marketable security that tracks an index, a commodity, or bonds like a index fund.
It mirrors the ebb and flow of a small portion of the market.
(Unlike mutual funds they trade like common stocks on the stock exchange: so the ETF price is constantly changing)
What are some things an ETF can track?
- The Russell 2k (small cap index)
- Gold futures
- The Krone (currency
- S and P TSX (transportation index)
Passive investing
(aka “buy and hold strategy”)
- involves limited ongoing buy and sell actions.
- unlike active investors, passive investors don’t attempt to profit from short term price fluctuations.
Big difference between ETF, closed-end fund, and mutual funds?
- ETFs and closed end funds trade like stocks, so their shares trade at market value, which can be:
- a dollar value above (trading at a premium)
or
- a dollar value below (trading at a discount) their NAV.
- A mutual fund’s NAV is calculated only once a day (at the end of the day).
Intraday
Within the day (within the trading day)
Creation unit
A set of shares or securities that make up one unit of the fund held by the trust that underlies an ETF.
- one creation unit is the denomination of underlying assets that can be redeemed for shares.
- one creation unit may equal 25,000 shares in the ETF
Redemption mechanism
Refers to how market makers of exchange traded funds can reconcile the differences between:
- NAV and market value when shares of the ETF are bought and sold.
Inverse ETF
(aka “short ETF”)
An ETF constructed through derivatives that lets you profit from a drop in a benchmark.
Often used in hedging.
They exist and can be purchased.
Leveraged ETF
ETF that uses derivatives to amplify both loss and gain potential.
If you buy a 2:1 leveraged ETF and it was up 1%, you would make 2%.
But if it was down 1%, you would also be down 2%.
Why are ETFs good investments?
They are especially good for:
- diversifying a portfolio
- reducing exposure to potentially risky market sectors.
How do ETFs “beat the market”?
1). ETFs are effective at reducing those factors that diminish returns:
- taxes
- fees
2) . With ETFs the goal is not to “beat the market” but to pick a fund that tracks an index with a good record.
3) . They offer more transparency (you can check its holdings daily) compared to mutual funds (which only put out a quarterly report).
4) they are good for diversifying
5) . They are very liquid
6) . They are passive investment vehicles, so they offer low expense ratios.
What led to the financial crisis of 2008?
(A collapse of the housing bubble that had been expanding for a decade)
- There was a growth of investment capital that large institutions used to tap into the mortgage industry.
- this in turn was fueled by rampant home buying.
- traders on Wall Street packaged mortgaged and sold them to eager buyers who wanted to cash in on rising housing prices.
- supplies ran thin, and then banks began issuing subprime mortgages to keep feeding demand.
- eventually, the market caught up with demand and housing prices (which had been artificially inflated by easy mortgages) dropped.
- banks and investors had no money (they had bought mortgage-backed securities with little money down)
- new investors became skittish
