ETFs are simple for the investor to use, however the underlying processes are more involved than some other investment solutions. There are two key aspects to how an ETF works.
1. The Secondary Market
In the secondary market buyers and sellers transact on the stock exchange – units are bought from/sold to another investor without any involvement/knowledge of the ETF sponsor. These transactions are processed throughout the trading day at negotiated (i.e. market) prices. Individual investor transactions have no impact the fund’s investment portfolio.
2. The Primary Market
What’s unique about ETFs is the creation/redemption process that takes place in the primary market. To create new units for sale in the secondary market, a designated broker delivers a basket of securities, which is determined by the ETF sponsor. In return, ETF units of equal value are delivered to the designated broker. The designated broker then sells the units to the public on the exchange to meet investor demand.