14 – L2 12 Misaligned ETF Pricing V3

Let’s see how an AP might seek out arbitrage opportunities with ETFs, and how that results in stable pricing of ETF shares. We’ll look at the iShares STOXX Europe 600 Retail ETF, which tracks eurozone retail companies. These include companies such as Inditex, which sells the Zara clothing line and is based in Spain. It also includes Henness and Mauritz, which sells the H&M clothing line and is based in Sweden. The iShares STOXX Europe 600 Retail or UCITS for short is tradable on the Bolsa Mexicana de Valores, which is the the largest stock exchange in Mexico. Let’s say that the investors in Mexico are very eager to invest in these European retail companies through ETFs and bid up the price of the ETF shares. This leads to a discrepancy between the ETF share price and the underlying prices of the stocks. We say that the ETF is trading at a premium to the net asset value or NAV because it is relatively expensive compared to the underlying stocks. If the ETF shares were cheaper relative to their NAV, we would say that they’re trading at a discount. Notice that this is the type of mispricing experienced by closed-end mutual funds. The actual difference is often referred to as the basis. We use this term because a basis point is defined as 0.01 percent or 1 divided by 10,000. Usually, the premium or discount is small enough that its unit of measurement is a few basis points.

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