ETFS: Mechanics and Applications Flashcards
When are mutual funds purchased and sold and at what price?
- Purchase or sold EOD
- Nav price
What does redeemed in-kind mean for ETF’s?
- exchange ETF shares for a basket of securities, rather than cash.
- exchanging shares market makers already own for shares of ETF
What are authorized participants (AP’s) in the creation/redemption process of ETF’s?
- special group of institutional investors, large brokers/dealers, or market makers who are authorized by the ETF issuer to participate in the creation/redemption process.
What is the creation basket and when is it published?
- list of securities (and share amounts) the authorized participant (AP or market maker) must deliver to the ETF manager in exchange for ETF shares.
- Creation basket is published every day.
What are creation units and how many shares are usually transacted?
- the lost size or number of shares transacted between authorized participant (AP) and ETF manager, usually but not always equal to 50,000 share of ETF
What is the difference between the creation basket and the redemption basket?
- creation basket: amount of securities AP must deliver to ETF manager in exchange for ETF shares
- redemption basket: amount of securities AP receives when it redeems ETF shares back to ETF manager.
How do AP’s make arbitrage profits and what’s the difference between ETF share creation and ETF share redemption?
- AP’s make arbitrage profits when there is a discrepancy’s between the ETF price and the fair value price of the underlying securities
- ETF share creation: when ETF price is trading above the fair value of the underlying securities, AP’s will short ETF and buy underlying securities
- ETF share redemption: when ETF price is trading below fair value of underlying securities, AP’s will long ETF and sell underlying securities
How do ETF’s shareholders avoid transaction costs?
- when AP’s make transactions the fees are passed along to the trader via the bid-ask spread instead of existing shareholders
Why can’t mutual fund shareholders avoid transactions costs?
- since there are no AP’s, mutual fund managers incur costs to transact, which is passed on to shareholders of the mutual fund.
What does the National Security Clearing Corporation (NSCC) and Depository Trust Company (DTC) do?
- NSCC: they gurantee transactions and clear trades
- DTC: adds up how many shares each firm is owed or how many the firm owes to a separate firm (eg. E trade owes Schwab 1,000 shares of SPY. Schwab owes BofA 1,000 shares of SPY. Schwab is whole since it’s owed 1,000 and owes 1,000. Therefore, E trade will be debited 1,000 shares and BofA will be credited 1,000 shares.)
How many days does National Security Clearing Corporation have to complete settlement of shares owed to firms and owed by firms?
- T+2 days (Trade date + 2 business days)
What is tracking errors for ETF’s?
- the difference between the performance of the ETF and the index it tracks
Why would one expect an ETF to underperform its benchmark and by how much?
- to account for the expense ratio, the tracking error for fund performance vs benchmark performance should be close to its expense ratio
What are a 5 sources of tracking error? FSAIF
- fees and expenses
- sampling or optimization (only holds some of the funds the benchmark holds)
- ADR’s instead of real securities
- index or benchmark change
- fund accounting practices (markets close at different times causing different closing prices)
What is counterparty risk for exchange traded notes (ETN)?
- risk that ETN issuer defaults (eg. Lehman brothers backed ETN’s defaulted due to Lehman Brothers bankruptcy)
