Question

1. Chloe is an individual investor who is bullish on the finance sector of the US equity market. Rather than purchase stock in several individual finance firms, Chloe decides to reduce trading costs by purchasing XLF, a US finance sector equity ETF. How can Chloe be confident that the price of XLF will closely track the net asset value (NAV) of the underlying shares of stock in the XLF benchmark index?

Answer 1

ETF stands for exchange traded funds and ETF replicates the performance of an index. XLF is an ETF which tries to replicate the performance of financial sector of the US market. Its component are majorly US financial institutions. When you buy an ETF at its NAV then when the underlying stocks or index do well then you NAV would increase. Since he is bullish on financial sector of the US market and if he bought the units in the XLF ETF then if the financial sectors do well then the share price of the companies in the financial sector will do well and the ETF nav will also increase so he will have capital gain. Chloe should be confident that the price of the XLF will closely track the NAV of the underlying shares because ETF replicates the performance of its underlying and those constituents when they do well the price of the ETF will also do well.