ETF - Page 3 DISTINCTIVE DIFFERENCES Despite certain similarities to mutual funds, ETFs are different in a number of ways. Of course, in either case, you risk potential loss of value if securities prices decline or if you sell in a falling market. ETFs trade throughout the day at current market price, while mutual funds shares trade only once, at the end-of-day price ETFs don't have to buy and sell shares to accommodate shareholder purchases and redemptions, minimizing portfolio turnover and the potential tax consequences of capital gains or losses ETFs can be bought on margin or sold short, even on a downtick, which is useful in hedging or other risk management strategies CREATING AN ETF Before you can buy shares in an ETF, the fund must be created. The fund sponsor, usually a major money management firm, seeks approval from the Securities and Exchange Commission (SEC) and then identifies authorized participants, usually institutional investors, to accumulate baskets of the securities that are included in a particular fund — stocks for a stock ETF or bonds for a bond ETF. The basket is equal in value to a fixed number of ETF shares. The sponsor forwards the securities to a custodian, usually a bank, for safekeeping in exchange for ETF shares. After the shares are created, investors buy and sell them through a brokerage firm, just as they do stocks. In fact, three ETFs — the Nasdaq 100, the SPDR, and the iShares Russell 2000 — are among the ten most actively traded stocks on the composite data for the Nasdaq Stock Market and the American Stock Exchange. << Back

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