Set out how ETF shares change hands on the secondary market
The idea
Most ETF investors never deal with the fund itself: they buy and sell shares on an exchange through a broker, at market prices throughout the day, using market or limit orders, and can sell short or buy on margin. Trading between investors does not change the number of shares outstanding, so most ETF volume involves no trading in the underlying securities at all. Liquidity therefore comes in two layers: the visible on-screen volume in the ETF, and the liquidity of the underlying basket, which market makers can tap through creations and redemptions by authorised participants. The trap is concluding that a thinly traded ETF must be illiquid when the securities it holds are highly liquid.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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- Explain how ETF shares are created and redeemed and what role authorized participants play
- Set out where ETF tracking error comes from
- Set out what influences the bid–ask spread on an ETF
- Set out why an ETF can trade above or below its NAV
- Set out what an ETF costs to hold
- Set out the risks ETFs carry
- Recognise and explain the ways ETFs can be used in a portfolio