SIE practice questionmediumETFs — Tracking Error
Tracking error in an ETF refers to:
- ATechnical glitches in the exchange's trading system
- BThe difference between the ETF's market price and its NAV
- CThe difference between the ETF's returns and the returns of its underlying benchmark index✓ Correct answer
- DErrors made by the fund manager when selecting stocks
Explanation
Why C — The difference between the ETF's returns and the returns of its underlying benchmark index
Tracking error measures how closely an ETF follows its benchmark index. Sources include: management fees, sampling (holding a subset of the index), cash drag, trading costs, and rebalancing timing. Lower tracking error indicates the ETF more closely mirrors the index. The difference between market price and NAV (C) is called the premium/discount, which is related but distinct from tracking error.
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