Exchange-Traded Funds vs Investment Trusts

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What role do authorized participants play in the context of ETFs?

They restrict buy and sell transactions to end-of-day NAV.

They create or redeem shares based on market demand. (correct)

They manage the assets of ETFs without any market impact.

They decide the price of the underlying assets in ETFs.

How do the pricing mechanisms of ETFs differ from those of mutual funds?

ETFs are priced based solely on the fund's NAV.

ETFs are traded at predetermined military prices.

ETFs are traded at market-determined prices throughout the day. (correct)

ETFs have no fluctuation in price during trading hours.

What is a significant feature of investment trusts compared to other investment types?

They issue a fixed number of shares that trade on the stock exchange. (correct)

They are designed to be highly liquid and flexible for investors.

They distribute profits to investors at the end of each trading day.

They are open-end funds that regularly create and redeem shares.

What distinguishes investment trusts from ETFs?

Investment trusts do not adapt to market demand for shares. Signup and view all the answers

Who typically manages the assets within an investment trust?

An in-house team of investment managers. Signup and view all the answers

What do hedge funds primarily aim to achieve?

Generative positive investment returns based on managers' skills Signup and view all the answers

Which strategy involves borrowing capital to increase position size?

Leverage Signup and view all the answers

What is the purpose of short-selling in hedge funds?

To bet against companies or assets believed to be overvalued Signup and view all the answers

What type of financial instruments are used by hedge funds to hedge risk or enhance returns?

Derivatives such as options, futures, and swaps Signup and view all the answers

What is a notable characteristic of many hedge funds regarding their location?

They are mostly based offshore in countries with unstrict financial regulation. Signup and view all the answers

What is the primary advantage of registering hedge funds with relevant regulators?

To ensure legal oversight and transparency Signup and view all the answers

What does the 2 and 20 fee structure in hedge funds refer to?

A 2% annual management fee and a 20% performance fee on profits Signup and view all the answers

How do hedge funds typically differ from mutual funds regarding investment liquidity?

Hedge funds impose restrictions limiting the access to invested capital for several years Signup and view all the answers

What is the primary goal of equity hedge strategies in hedge funds?

To profit from both rising and falling stock prices based on market insights Signup and view all the answers

What is short-selling in the context of hedge funds?

Selling shares that one does not own, betting that prices will decline Signup and view all the answers

What is a key characteristic of Contracts for Difference (CFDs)?

They allow speculation on price movements without owning the asset. Signup and view all the answers

Which of the following statements about leverage in CFD trading is true?

Leverage enables trading with only a fraction of the total trade value. Signup and view all the answers

What does margin represent in the context of trading CFDs?

The minimum balance required in the trading account. Signup and view all the answers

Which type of CFD typically involves speculation on currency pairs?

FOREX CFD Signup and view all the answers

Which of the following options accurately describes the nature of CFDs?

They capitalize on asset price fluctuations without ownership. Signup and view all the answers

What is the main goal of fixed-income arbitrage?

To buy underpriced bonds and short-sell overpriced bonds Signup and view all the answers

What distinguishes a Defined Benefit (DB) pension plan from a Defined Contribution (DC) pension plan?

DB plans promise a set percentage of final salary as pension Signup and view all the answers

How does macro arbitrage primarily generate returns?

By taking large directional bets on markets using leverage Signup and view all the answers

What is a key characteristic of personal pensions?

They allow individuals to contribute independently to their retirement savings Signup and view all the answers

What is the primary purpose of life assurance?

To provide a lump sum to beneficiaries upon the death of the policyholder Signup and view all the answers

Which of the following best describes merger arbitrage?

Buying shares of takeover targets and shorting shares of acquirers Signup and view all the answers

What does reinsurance primarily help insurance companies achieve?

Reduce their exposure to significant claims Signup and view all the answers

Which statement accurately describes state pensions?

They provide basic income based on national insurance contributions Signup and view all the answers

What are the two primary contributions sources in an occupational pension?

Employer and employee contributions Signup and view all the answers

What is a defining feature of proportional reinsurance?

The insurer and reinsurer share premiums and claims in a fixed ratio Signup and view all the answers

What distinguishes emerging market investing from other forms of investment?

Positions often taken in markets where shorting is difficult or impossible Signup and view all the answers

Which component is NOT a part of life assurance?

Guaranteed dividends Signup and view all the answers

What is the objective of macro arbitrage strategies?

To leverage market trends for substantial directional bets Signup and view all the answers

Which type of pension plan is considered unfunded?

State pension Signup and view all the answers

What is a critical difference between health insurance and life assurance?

Health insurance focuses on expense coverage, while life assurance pays upon death Signup and view all the answers

Study Notes

ETFs

Shares prices can fluctuate based on demands
Authorized participants can create or redeem shares to help maintain ETFs liquidity and price stability
Allows investors to buy and sell ETFs shares throughout the trading day
Hybrid of a tradable stock and index-tracking fund
Combine diversity of a mutual fund with the liquidity and flexibility of stock trading
Pricing is determined by the market, can trade at/close to NAV
Charges range between 0.2% and 0.75%

Investment Trusts

Set up as companies and floated on the Stock Exchange
Over 400 investment trusts on LSE, total assets of £80 billion
Closed-end funds, issue fixed no.of shares that trade on the stock exchange
Don't create or redeem shares based on demand, instead shares are bought and sold in the open market
Run by in-house team of investment managers
Aim to grow the trusts' value by investing in line with its stated goals
Share prices are determined by market and can trade at a premium or a discount to the NAV

Hedge Funds

Attempt to generate positive investment returns based on managers' skills
Employ various strategies not normally used in mutual funds:
- Leverage: borrow capital to increase position size, allows investors to take on larger bets but increases risks
- Short-selling: selling shares that they do not own, frequently used to bet against companies or assets that investors believed that are overvalued or expected for downturn, particularly valuable in falling or volatile markets
- Use of derivatives: Derivatives such as options, futures and swaps are often used to hedge risk, speculate or enhance returns, help funds to take large positions with relatively small initial investment
Mostly based offshore in countries with unstrict financial regulation
Fee structure (2 and 20 fee structure): 2% annual management fee on total assets, 20% performance fee on profits for managers
Usually need to be registered with relevant regulators
Privately managed to certain investors only
Might specialized in certain sector/industry/institutional
Investors are restricted to keep their money for 2-5 years

Short-selling

Sell shares that you do not own (borrowing shares and then sell in the future)
A way of profiting from share prices going down
A common strategy in hedge funds

Hedge Fund Strategies

Equity hedge: Profit from price movements in individual stocks based on the managers' market insights
Fixed-income arbitrage: Buys underpriced bonds, while shortselling similar (overpriced) issues
Merger arbitrage: Buys shares in takeover targets while shorting shares of the acquirer
Macro: takes large directional bets on markets, often using leverage to increase returns
Emerging market: Takes positions in emerging market securities (where shorting is often impossible)

Pension Funds

Investment pool that collects and manage retirement savings for individuals or employees
3 sources of pension income:
- State pension: government-provided pension that offers basic income upon retirement, pay-As-You-Go (PAYG) method
- Occupational pension: established by employers to provide retirement benefits for their employees, pre-funded with employer and often employee contributions, 2 types:
  - Defined Benefit (DB): employer promises set % of pay pension, employee may contribute, but employer bears balance of cost
  - Defined Contribution (DC): Employer and employee contribute to the fund, employee chooses how to invest the fund
- Personal pension: Retirement savings plans that individuals can set up independently of their employer, funded with individuals contributing their own money

Life Assurance

Financial product where individuals pay premiums to an insurance company, which promises to pay a specified lump sum to policyholders' dependents upon their deaths
Designed to provide financial security and support for beneficiaries
Key components:
- Premium payments: Policyholders pay regular premiums to maintain life insurance policy
- Lump sum payout: Life insurance company pays a fixed amount to beneficiaries upon the policyholder's death
- Fixed liability: Amount of liability is predetermined and fixed at the time of policyholder's lifespan
- Investment strategy: fund (pool of premiums collected from policyholders) will be invested in assets:
  - Government and corporate bonds
  - Stock and equities
  - Real estate
  - Other assets

Reinsurance

Financial practice in which insurance companies reduce their exposure to significant claims by transferring part of their risk to another insurer, called "reinsurer"
Helps insurers maintain financial stability and manage risk more effectively
Reinsurance enhances the primary insurer's capacity to underwrite policies, improves solvency
Types of reinsurance:
- Proportional reinsurance: insurer and reinsurer share premiums and claims in a fixed ratio

Contracts for Difference (CFDs)

Financial agreement between 2 parties, that stipulates that the buyer will pay the seller the difference between the current value of an asset and its value at the time the contract was initiated
Form of derivative, cash settled
Very short-term
Essentially bets as to whether the price of the underlying asset or security will rise or fall:
- Those expecting an upwards movement in price will buy the CFD
- Those expecting a downwards movement will sell the CFD
OTC
Trade on margin
Tradeable contract between a client and their broker
Offer benefits and risks of owning a security without owning it
Leverage allows investors to put up only a small percentage of the trade amount with a broker
Common types:
- Commodity CFD
- Index CFD
- Share CFD
- FOREX CFD
- Cryptocurrency CFD

Margin & Leverage

Margin represent the minimum balance you will need in your account to trade (often expressed as a percentage of the trade value)
Brokers may offer leverage, and this can differ based on:
- Underlying contract
- Contract size
- Type of clients

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz explores the key differences and features of Exchange-Traded Funds (ETFs) and Investment Trusts. Understand how share pricing, liquidity, and trading mechanisms vary between these investment vehicles. Test your knowledge about their structure, benefits, and market behavior.