This Question belongs to candidate resource Q24.
Provident Advisers is a registered investment advisory firm that uses exchange-traded funds (ETFs) for its clients’ investment portfolios. Ted Sorrill is CEO and chief investment officer of Provident. Steve Mives, a prospective client, is a high-net-worth individual who is considering transforming his actively managed portfolio of individual stocks and bonds into actively managed and passive ETFs. Mives is considering this strategy because of the advice of his accountant, Andrew Hart. Sorrill, Mives, and Hart are meeting to discuss ETFs and their growing use in the construction of investment portfolios. Sorrill begins the meeting by describing how ETFs are subject to the same regulations as mutual funds and noting that ETFs trade intra-day, similar to public stocks. Hart adds that ETF authorized participants conduct trades in the secondary market to eliminate the arbitrage gap and conduct trades in the primary market to both create and redeem ETF shares.
Is Hart’s statement about ETF authorized participants most likely correct?
A. Yes
B. No, regarding trades in the primary markets
C. No, regarding trades in the secondary markets
I selected A “Yes”, however the correct answer is C, I think AP also trade in secondary market when he finds opportunity of arbitrage or opportunity of earnings.
You are correct that ETF authorized participants (APs) can indeed trade in both the primary and secondary markets, depending on the circumstances.
In the primary market, APs are responsible for creating and redeeming ETF shares. When they create new shares, they typically exchange a basket of underlying assets for ETF shares. When they redeem shares, they exchange ETF shares for the underlying assets. This primary market activity helps keep the ETF’s market price closely aligned with its net asset value (NAV).
In the secondary market, APs can also engage in arbitrage activities to ensure that the ETF’s market price closely tracks its NAV. If the ETF’s market price deviates significantly from its NAV, APs can buy or sell ETF shares on the stock exchange to profit from this price discrepancy.
So, while ETF authorized participants primarily play a role in the primary market for creation and redemption of shares, they can also engage in trading in the secondary market when there are arbitrage opportunities. Therefore, the correct answer should be B. “No, regarding trades in the primary markets” because Hart’s statement is incorrect regarding the primary market role of APs.
But they have given Option C as the correct answer.
But they do trade in the secondary market, and because of their active involvement in the secondary market, the price of ETF stays close to NAV. Then why have they given secondary market trade as the wrong answer