The key terminologies associated with ETFs is important for crossing this investment decisions. Here’s a glossary of the most important terms you’ll encounter:
Net Asset Value (NAV):
The NAV represents the per-share value of the ETF’s assets minus its liabilities.
It’s calculated at the end of each trading day and serves as a benchmark for the ETF’s market price.
Expense Ratio:
This is the annual fee that ETF providers charge investors to cover the fund’s operating expenses.
It’s expressed as a percentage of the fund’s average net assets.
Example:
If an ETF has an expense ratio of 0.50%,in simple words it means you need to pay ₹5 annually for every ₹1,000 invested.
Tracking Error
This measures how closely an ETF follows its benchmark index. A lower tracking error indicates that the ETF’s performance is closely aligned with its index.
Arbitrage
This refers to the practice of buying and selling ETF shares to profit from price discrepancies between the ETF’s market price and its NAV. Arbitrage helps keep the ETF’s market price in line with its NAV.
Creation Unit
This is a large block of ETF shares (typically 50,000 shares) that authorized participants can create or redeem in exchange for the underlying assets. Creation units facilitate the arbitrage process.
Authorized Participant (AP)
These are large financial institutions, such as banks or brokerage firms, that have the right to create or redeem ETF shares directly with the ETF provider.
Liquidity
This refers to how easily ETF shares can be bought or sold in the market without significantly affecting their price. ETFs with higher liquidity are easier to trade.
Bid-Ask Spread
This is the difference between the highest price a buyer is willing to pay (bid) for an ETF share and the lowest price a seller is willing to accept (ask). A narrower bid-ask spread indicates better liquidity.
Dividend Yield
This is the annual dividend income paid by the ETF expressed as a percentage of its market price. It’s an important metric for income-focused investors.
Underlying Assets
These are the actual securities (stocks, bonds, commodities, etc.) that the ETF holds to replicate the performance of its benchmark index.