SIE practice questionhardETFs — Creation/Redemption
The creation and redemption mechanism of ETFs involves:
- AThe SEC approving each individual purchase and sale
- BAuthorized Participants (APs) exchanging baskets of underlying securities for ETF shares (and vice versa) in large blocks called creation units✓ Correct answer
- CIndividual investors directly purchasing and selling shares with the ETF sponsor
- DThe ETF manager buying and selling shares on the open market daily
Explanation
Why B — Authorized Participants (APs) exchanging baskets of underlying securities for ETF shares (and vice versa) in large blocks called creation units
ETFs use an in-kind creation/redemption process. Authorized Participants (large institutional firms) exchange baskets of the underlying securities for creation units (typically 25,000-50,000 ETF shares). This mechanism keeps the ETF's market price close to its NAV through arbitrage, provides tax efficiency (avoiding taxable sales), and ensures liquidity. Individual investors buy/sell on the exchange, not directly with the fund.
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