Question

Suppose that an ETF trades at a price below its net asset value. Describe what authorized participants (APs) could do to take advantage of this discrepancy. What would be the likely effect of the APs’ actions?

Answer 1

When there is discrepancy in the ETF, which happens in very few occasions. The Active participants exploit these differences and use the mispricing to gain profit through arbitrage.

When an asset sells below the NAV, then the AP  will pick these assets and sell these assets at a profit when the assets are overpriced.

The likely effect of these arbitrage trades is that these trades bring the market price of the ETF back to the NAV. They help eliminate the mispricings in the market.