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3 Income Investing Using ETFs

Creating & Redeeming ETFS

While ETFs trade on an exchange like stocks, the process by which their units are created is significantly different. Unless a company decides to issue more units, the supply of units of an individual stock trading in the marketplace is finite. When demand increases for units of an ETF, however, Designated Brokers (DBs) have the ability to create additional units on demand. Through an "in kind" transfer mechanism, DBs create ETF units in the primary market by delivering a basket of securities to the fund equal to the current holdings of the ETF. In return, they receive a large block of ETF units (typically 50,000), which are then available for trading in the secondary market. This creation and redemption mechanism helps keep ETF supply and demand in continual balance and provides a "hidden" layer of liquidity not evident by looking at trading volumes alone.

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