Exchange-traded funds and the new dynamics of investing by Ananth N. Madhavan

By Ananth N. Madhavan

"In Exchange-Traded cash and the recent Dynamics of making an investment, Ananth Madhavan examines the quiet transformation of asset administration during the upward push of passive or index making an investment. A closely-related phenomenon is the increase of exchange-traded cash (ETFs). An ETF is an funding motor vehicle that trades intraday and seeks to copy the functionality of a particular index. ETFs have grown considerably in dimension, range, and

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Exchange-traded cash (ETFs) have grown considerably in dimension, variety, and marketplace value lately, producing enormous curiosity from traders, teachers, regulators and the Read more...

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For an arbitrager who trades the ETF and the underlying basket, the gross profit (excluding transaction costs and fees) from trading by buying the cheaper asset and selling the more expensive asset is ut per share traded. The profit of a market maker is not the ETF’s premium to NAV (unless true value aligns with NAV) but the deviation of price from expected value, ut . While creations and redemptions are at NAV, this is really an end-​of-​day accounting or book entry transaction. ), the market maker can sell the ETF while simultaneously purchasing the basket of securities (or obtaining that exposure through some other mechanism such as a swap) to make an expected profit.

The ETF sponsor originates the fund and selects its investment objective. The great majority of ETFs are index-​based, where the sponsor chooses both an index and a method of tracking its target index. See Gastineau (2010) for a detailed description. 2. ETFs are a subset of a broader group of investment vehicles termed exchange-​t raded products (ETPs). In an ETF, the underlying basket securities are physically represented with the objective of mimicking the performance of a broad market index.

1. 2 In particular, ETFs share elements of both open-​and closed-​end mutual funds. For an open-​ ended mutual fund, transactions occur only at the end of the day and only at net asset value or NAV. In contrast to open-​ended mutual funds but like closed-​end funds, ETFs trade during the day in the secondary market at prices that can deviate from NAV. Further, unlike open-​ended mutual funds, ETFs issue and redeem shares only in a minimum size (creation unit) and only with market-​making firms known as Authorized Participants (APs).

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