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ETFs 101: Introduction to Exchange-Traded Funds

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1.
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.
2.
Exchange-traded funds are always cheaper to buy than mutual funds.
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False. If you trade frequently, ETFs will likely be more expensive than mutual funds, due to the commissions.
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.
When can you buy exchange-traded funds?
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Anytime during the trading day. As opposed to mutual funds, which are sold at the end of the day no matter when during the day you place your order, you can buy exchange-traded funds at any time during the day.
5.
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.