Chapter 02 · Beginner · 6 min read
Under the Hood
What actually happens when you buy an ETF?
Follow your order from broker to exchange and understand who keeps the fund working.
The index is the recipe
Imagine a playlist called ‘The 500 Biggest US Companies’. It has rules for what belongs and how much each company counts. That is what an A rules-based list of investments used as a recipe or a benchmark. does: the index is the recipe, and the Exchange-traded fund — a basket of investments you can buy and sell like a single share. is the meal made from it.
A passive Exchange-traded fund — a basket of investments you can buy and sell like a single share. generally follows an A rules-based list of investments used as a recipe or a benchmark.. An active ETF has a manager making decisions within a stated mandate.
Creation and redemption
Exchange-traded fund — a basket of investments you can buy and sell like a single share. shares trade on an exchange while the portfolio underneath has its own value. Specialist market participants can create or redeem blocks of ETF shares, helping keep the trading price close to the value of the assets.
The ETF ecosystem
The provider manages the fund, an A rules-based list of investments used as a recipe or a benchmark. provider creates the benchmark, the exchange hosts trading, market makers support How easily you can turn something into cash without moving the price., and your broker connects you to that market. You decide whether the result fits your plan.
Words worth knowing
Open dictionary- Passive ETF
- A fund designed to follow an index.
- Market maker
- A participant posting buy and sell prices to support trading.
- Redemption
- The process of exchanging ETF shares for underlying assets.
In the recipe analogy, what is the ETF?
Try it yourself
Choose one ETF and identify its fund provider, index provider and exchange listing.
Can you spot it?
An ETF trades 4% above the value of its holdings. Which part of the ecosystem has an incentive to close that gap?