Exchange traded funds –ETF, are securities which follows an index, a basket of assets, or commodities similar to an index fund. Different kinds of financial companies are required for the ETF to come into existence, in order to trade, and unwind when investors no longer desire them. Fund manager is the key person behind every ETF and he has to submit a detailed report on the operation of every Exchange traded funds, to the Securities exchange commission, in order to get the permission. Only after a detailed examination of the application submitted, the SEC will allow the firm to create the ETF. As per the reports, till date no investor has ever lost money after investing in ETFs.
Hence, every Exchange traded funds has a right over a fraction of a basket of individual stocks. On an exchange, ETF trades like a stock. Since the traded funds, are bought and sold every day, its value records many ups and downs in a single day. Exchange traded funds operate like a stock; its Net Asset Value is not calculated every day, unlike mutual funds. ETFs can be bought from any of the brokerage company.
By having the possession of an Exchange traded funds, the owner gets index fund diversification, he can always sell short, can be bought on margin, and able to purchase as lesser as one share. At the same time, the investor only has to pay the same brokerage that would be payable to any regular order.
The Exchange traded funds are sold and bought freely by investors in the open market. When it comes to redemption, it is the reverse process of creation of an ETF. The approved representative buys a big block of ETFs from the open market and sends the same to the custodial bank. In return the bank gives back an equal basket of individual stocks to the authorized person, which are then sold in the open market or else, it can be returned to the respective loanees.
What is the factor that encourages each player? A small portion of the annual assets, as stated in the prospectus is taken by the fund manager. The investor receives a small interest free for their basket of stocks. The bank too receives a small part of the assets in the same way. These fees are paid from the management fee by the fund manager. On the other hand the authorized participant is motivated by the revenue earned from the variation in price between the basket of stocks and the exchange traded funds.
Spider is one of the well known Exchange traded funds; it tracks the S&P 500 index.