iShares and Exchange-Traded-Funds

Barclay’s Global Investors pioneered the exchange-traded fund (ETF) business with its iShares brand. iShares is a security fund that tracks a bond or a market index and is listed on the American Stock Exchange (AMEX), and the New York Stock Exchange (NYSE), and the Toronto Stock Exchange (TSX) in North America, and on other European and Asian stock exchanges.

iShares, and other ETFs such as Standard & Poor’s Depository Receipts (SPDRs), are directly linked to the indices they track. ETFs are security certificates of ownership on the index, sector, bond, or commodity they are modeled to represent. These baskets are held by a custodial financial institution for safekeeping and double-checking for accuracy, who then return the ETF shares to the middleman, known as a market maker or specialist. Baskets are large chunks of stock – anywhere from 10,000 to 50,000 shares. This market specialist can then sell the representative ETF shares to investors. Investors then can openly buy and sell the ETF shares on the market. If an investor were to acquire enough iShares to represent a complete iShares basket of the S&P 500 index, for example, that basket could be redeemed for all 500 companies in the S&P 500.

All of these ETF transactions are tracked through the Depository Trust Clearing Corporation, just like all other stocks are. ETF shares are directly tied to their underlying asset value, so it’s quite simple to determine if the ETF share is undervalued or selling at a premium. With the creation of these kinds of securities, investors now have the option to trade a security with fund-like qualities with all the features of stock trading like short selling, limit orders, stop-loss orders, and margin buying. This is impossible or meaningless with a mutual fund. Also, the ETFs can be traded throughout the trading day and not only at the end of the day as is the case with mutual funds.

ETFs are easily traded but are complicated in their structure.  Here is an excellent video from Nick Perry of Schaeffer’s Investment Research.

[youtube]http://www.youtube.com/watch?v=PIRI8SsBrxo[/youtube]

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