SIE practice questionmediumETFs — Premium and Discount to NAV
If an ETF's market price exceeds its intraday NAV (iNAV), the ETF is trading at:
- AA discount, which authorized participants will correct by creating new shares
- BParity, meaning no arbitrage opportunity exists
- CA premium that cannot be corrected because ETFs are fixed-share vehicles
- DA premium, which authorized participants will correct by creating new shares (increasing supply to bring the price down)✓ Correct answer
Explanation
Why D — A premium, which authorized participants will correct by creating new shares (increasing supply to bring the price down)
When an ETF trades at a premium (market price > NAV), Authorized Participants can profit through arbitrage by buying the underlying basket of securities, exchanging them for ETF shares (creation), and selling the ETF shares at the higher market price. This increases the supply of ETF shares, bringing the market price back toward NAV. This creation/redemption mechanism keeps ETFs trading close to NAV.
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