Exchange-Traded Funds: Mechanics and Applications (2024 Level II CFA® Exam - PM-Module 1)

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Topic 9 - Portfolio Management
Module 1 - Exchange-Traded Funds: Mechanics and Applications
0:00 Introduction and Learning Outcome Statements
12:30 LOS: Explain the creation/redemption process of ETFs and the function of authorized participants.
16:40 LOS: Describe how ETFs are traded in secondary markets.
19:00 LOS: Describe sources of tracking error for ETFs.
24:03 LOS: Describe factors affecting ETF bid-ask spreads.
28:53 LOS: Describe sources of ETF premiums and discounts to NAV.
30:35 LOS: Describe the costs of owning an ETF.
32:02 LOS: Describe types of ETF risk.
33:17 LOS: Identify and describe portfolio uses of ETFs.

[@paretrdr]

Thank you for this sir! This completes my understanding of the mechanism of ETF in the point of view of a market-maker.

[@jonathanupham2476]

Not sure that Apple freezer analogy worked. I’m more confused

[@naomiswann3796]

This might help: Creation and Redemption Process of ETFs:
Imagine the ETF issuer is a toy factory. The toys they make are the ETF shares. But instead of using plastic or wood, they use stocks, bonds, or other assets to make these toys.
The Authorized Participants (APs) are like the toy distributors. They have a special agreement with the factory that allows them to exchange raw materials (the stocks, bonds, etc.) for finished toys (the ETF shares). This is the creation process.
Now, imagine there are too many toys on the market, and the price of the toys starts to drop below the value of the materials used to make them. The APs see an opportunity. They buy up the toys, bring them back to the factory, and exchange them for the raw materials. This is the redemption process.
Through these creation and redemption processes, the APs help keep the price of the toys in line with the value of the materials used to make them.
Trading ETFs in Secondary Markets:
Now, let's talk about the secondary market. This is like a giant online marketplace, like eBay, where anyone can buy and sell toys (ETF shares).
Most people don't deal with the toy factory (ETF issuer) or the toy distributors (APs). They just buy and sell toys on the marketplace.
The price of the toys on the marketplace is determined by supply and demand. If lots of people want a particular toy, the price goes up. If no one wants it, the price goes down.
But remember the toy distributors (APs)? They're always watching the marketplace. If the price of a toy gets too high compared to the value of the materials used to make it, they'll bring more toys to the market. If the price gets too low, they'll take toys off the market. In this way, they help keep the price of the toys on the marketplace in line with the value of the materials used to make them.
Hopefully, these analogies make the concepts easier to understand.

[@MouliBeesetti]

@@naomiswann3796 Very good explanation...

[@paretrdr]

@@naomiswann3796 Thanks for the clear explanation. Someone can also find a visual explanation of ETF's creation/redemption mechanism at Fidelity website, where they use a flower factory and flower shop as the ETF issuer and the secondary market respectively.

[@hws2152]

HIGH tracking error pave way to ARBITRAGE OPPORTUNITY?

[@argos2872]

Good

[@analystprep]

Thanks

[@MouliBeesetti]

Why don't you use pen or mouse pointer to explain... Your explanation will be much better if you do it..