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ETFs 101: Exchange-Traded Funds

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1.
The price of an exchange-traded fund on the market is _______.
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Either the net asset value or a price higher or lower than that. Exchange-traded funds do not necessarily trade at the net asset values of their underlying holdings; they are sometimes higher or lower, based on demand and other factors.
2.
Compared to mutual funds, exchange-traded funds are ______ to make capital-gains distributions.
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Less likely. However, at times they must, in order to adjust for changes to their underlying indexes.
3.
Which statement is true about exchange-traded funds (ETFs)?
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The arbitrage mechanism that keeps ETFs' prices in line with their NAVs should work most of the time. Differences between an ETF's price and its NAV can occur with those ETFs that aren't traded very often. Also, it's unclear how well the arbitrage mechanism will work during a full-fledged market correction.
4.
Exchange-traded funds typically are _______.
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Passively managed, or indexed. For the arbitrage mechanism to work, potential arbitragers must have full, timely knowledge of the ETF's holdings. Active managers rarely disclose this information more than twice per year, though, which is why indexing has been the strategy of choice for ETFs thus far.
5.
If you are an active, frequent trader of exchange-traded funds, then your trading expenses will probably _______ those of mutual funds.
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Exceed. Those who trade frequently will probably discover this. So if you plan to trade ETFs frequently, you should take note.