Exchange Traded Funds (ETFs) are investment vehicles that trade on an exchange, such as NYSE Euronext’s Arca and European exchanges. They combine the trading flexibility of individual stocks with the diversification benefits of index fund investing.
Through ETFs, investors can buy or sell shares in the collective performance of an entire portfolio as a single security. ETFs are also beneficial because they are relatively low cost compared to mutual funds and they have high tax efficiency.
An ETF holds assets such as stocks, commodities, or bonds and provides investment results that generally correspond to the price and yield performance of an underlying benchmark index.
For instance, the portfolio of securities that makes up the iShares NYSE Composite ETF try to mirror the performance of the NYSE Composite Index.
ETFs can issue new shares and redeem existing shares on any trading day, in a process referred to as creation and redemption, which is open to qualifying entities that register as Authorized Participants (AP) with the fund. This mechanism allows an AP to exchange a portfolio of stocks and receive ETF shares in return (i.e., a “creation”). Similarly, an AP can “redeem” ETF shares and receive the portfolio of stocks. The creation/redemption process can in some instances (or for some funds) occur using cash.