General Fixed Income

Exchange traded funds offer institutional investors unique opportunities to... instantly establish, increase or decrease exposure to broad U.S. and international equity markets and sectors and U.S. bonds track a benchmark through a single execution trade equity and bond market exposure as easily as stocks, throughout the day, buy on margin, sell short, and use limit and stop orders

In recent years, these unique opportunities have helped exchange traded funds explode in popularity and emerge as one of the most flexible, multi-purpose investment vehicles available. Ever since the American Stock Exchange pioneered the concept of a tradable basket of stocks with the creation of the Standard & Poor's Depositary Receipt (SPDR) in 1993, exchange traded funds have evolved into an entirely new investment category. Today, the number of ETFs listed and traded at the Amex has grown to more than 100 and continues to grow—not only in the number of products and their variety—but also in terms of assets and market value.

What are exchange traded funds? Exchange traded funds (ETFs) represent shares of ownership in either funds or unit investment trusts that hold portfolios of common stocks or bonds, which are designed to generally correspond to the price and yield performance of their underlying indexes,* either broad stock market, stock industry sector, international stock, or U.S. bond. ETFs give investors the opportunity to buy or sell an entire portfolio of stocks or bonds in a single security, as easily as buying or selling a share of stock. *iShares COMEX Gold Trust is not an index fund. See the prospectus for more information.

ETFs offer a wide range of investment opportunities. Creation and redemption feature ETF structure ETFs vs. futures

The advantages of ETFs Tax efficiency Lower costs (ordinary brokerage commissions apply) Transparency Buying and selling flexibility All day tracking and trading Diversification Dividend opportunities Wide array of investment strategies Equitizing cash Managing cash flows Equity/fixed income asset allocation Sector/country exposure Hedge strategies Relative value, long/short strategies Transitions To view risks and other considerations, click here. To view FAQs, click here.

Creation and Redemption ETFs are open-ended, with a unique Creation and Redemption feature that only provides for the creation of large blocks of ETF shares by Authorized Participants to satisfy investor demand and provide market liquidity. A creation requires the deposit with the trustee of a specified portfolio of stocks or bonds closely approximating the composition of the specific index and specified amounts of cash in return for a Creation Unit aggregation of shares of a specific exchange traded fund. The redemption process is the same but in reverse. Creations and redemptions are restricted to large transactions, typically in creation unit multiples of 50,000 shares, but ranging from 25,000 to 600,000 share creation units.

Pricing Accuracy—The Creation and Redemption process prevents significant premium/discount. Although supply and demand determine the market price of an exchange traded fund, just like any other security, arbitrage helps keep the traded price of an ETF much more in line with its underlying value. By simultaneously buying (or selling) the ETF "basket" and selling (or buying) the ETF shares in the secondary market, then creating (or redeeming) ETF shares to be delivered against the sale, arbitrageurs can capture the price discrepancy and make a profit.

Liquidity—The Creation and Redemption process is also able to infuse the ETF marketplace with considerable liquidity, as its open-ended structure permits it to capture liquidity from the underlying shares, futures, options, etc., at any time during trading hours. As a result, for exchange traded funds, volume in the ETF is not necessarily a good indicator of liquidity. New shares can be created readily to meet demand, so the specialist and market makers typically are able to provide greater liquidity than the volume in the ETF would indicate.

ETF Structure

ETFs are open-ended registered investment companies under the Investment Company Act of 1940 that have been granted certain exemptive relief from the SEC to allow secondary market trading in the ETF shares on the Amex.

ETFs vs. Futures Many institutions use futures to buy or sell exposure to an index for the short term. However, to gain exposure for a longer period, costs associated with trading ETFs may be lower. ETFs avoid the basis point risk and additional transaction costs that are required in rolling futures positions forward each quarter. Futures also face daily variation margin calls that must be met with cash, while ETFs, unless margined, are purchased outright with no threat of a margin call.

ETFs also serve as an alternative for institutions or money managers seeking to trade index exposure, but do not use futures or are subject to policy restriction prohibiting the use of futures in their strategy.

Exchange traded funds may also provide exposure to specific indexes or market segments not accessible with futures, and may offer more choices than futures for achieving exposure to country-specific, international region, domestic stock or bond markets or stock industry indexes.

The advantages of ETFs Tax efficiency ETFs, like index funds in general, tend to offer greater tax benefits because they typically generate fewer capital gains than actively managed funds due to low portfolio turnover. Generally, an ETF only sells securities to reflect changes in the composition of its corresponding index. Exchange trading of ETFs further enhances their tax efficiency. Investors who want to liquidate shares in an ETF simply sell them to other investors, thus not requiring the fund to sell securities and generate capital gains tax liability. In addition, the Creation and Redemption process involves an “in kind” transfer of securities, a transaction that is not a taxable event for the fund or trust. This means that imbalances between supply and demand for ETF shares can be satisfied through the creation and redemption process and will not have an adverse taxable effect upon existing ETF shareholders.

Lower costs Lower turnover costs--Because they are index-based, ETFs require few portfolio changes, resulting in much lower transaction costs than actively managed portfolios. Lower expense ratios--As passive investments, ETFs also have lower operating expenses and lower management fees, resulting in lower annual expense ratios than many other registered investment products. Lower operational costs--Since ETFs trade on an exchange and use "in kind" Creation and Redemption, they are insulated from the costs of buying and selling securities to accommodate shareholder purchases and redemptions. Lower trading costs--Spreads on many ETFs tend to be narrow making them inexpensive to buy and sell. Of course, some ETFs will have much wider spreads and the cost of these spreads, as well as commission costs, should be taken into account when assessing the overall costs of exchange traded funds.

Transparency To facilitate an ETF's unique Creation and Redemption process, the composition file for each ETF creation unit is published daily. Since an ETF's holdings are designed to provide performance similar to its underlying index, investors will essentially know the securities that are held in an ETF and their weightings.

Buying and selling flexibility Because they are exchange traded, ETFs can be: bought and sold at intraday market prices purchased on margin sold short traded using stop orders and limit orders

All day tracking and trading Investors can track ETF prices throughout the trading day and adjust portfolio holdings to capitalize on changes in the market.

Diversification Because each ETF represents a basket of stocks or bonds, it inherently provides diversification across an entire index. Additionally, the expanding universe of ETFs available at the American Stock Exchange offers exposure to a diverse variety of markets, including: broad-based equity indexes (such as total market, large-cap growth, and small-cap value) broad-based international and country-specific equity indexes (such as Europe, EAFE, and Japan) industry sector-specific equity indexes (such as healthcare, energy, and real estate) U.S. bond indexes (such as long-term Treasury bonds and corporate bonds)

Dividend opportunities Dividends paid by companies and interest paid by bonds held in an ETF are distributed to ETF holders, less expenses, on a pro rata basis. Of course, not all companies will pay dividends. Based on past performance, few, if any, distributions can be expected from certain ETFs. There may also be opportunities for reinvestment of distributions.

Wide array of investment strategies Money managers use ETFs as a hedging vehicle, or as a means of equitizing cash or maintaining market exposure during periods of transition. Financial advisers like ETFs because they are tax efficient, easy to trade and relatively inexpensive. Effectively, the convenience of ETFs enables the pursuit of a wide variety of investment strategies. Equitizing cash—Institutions with temporary idle cash can put it to work in an ETF while determining where to invest for the longer term. Investors can maintain allocations or establish new allocation targets to a benchmark or sector, investing and liquidating as needed to fulfill redemption requests. This can minimize cash drag or trading risk. Managing cash flows—Investment managers can take advantage of ETFs' liquidity during periods of cash inflows and outflows. A portfolio manager can establish a position in an ETF that corresponds to the portfolio's benchmark or investment strategy, investing inflows into the ETF and liquidating the position as needed to meet redemptions or invest in specific stocks or bonds. Equity/fixed income asset allocation—Investment managers divide assets among baskets of stocks and bonds with the ease of stock trading. Sector/country equity exposure—Exchange traded funds offer institutions immediate diversified exposure to a sector or country. For example, managers can quickly and easily purchase ETFs for instant and extensive international exposure, compared to the expense and difficulty of assembling a portfolio of foreign securities. Hedge strategies—Since ETFs can be sold short they provide easy to employ risk management strategies. In a declining equity market (or rising interest rate market for fixed income ETFs), profits from a short position can offset some of the losses in a portfolio. A money manager can use these strategies to protect a portfolio from overall market losses and preserve it or capitalize on negative volatility of a market segment, specific sector, or interest rates. Hedging involves additional and specific risks and does not guarantee protection from loss of principal or ensure a profit. Completion strategies—Fund or money managers can use ETFs to quickly establish or increase exposure to an industry or sector to "fill holes" in an overall investment strategy. Relative value, long/short strategies—Institutions can take advantage of ETF features to combine long and short strategies aimed at increasing returns. For example, an institution can establish a long position in a broad-market, country, sector, or bond index expected to outperform while shorting an index expected to underperform. Increasing the size of the long position versus the short position can leverage the total position. Transitions—Pension plan assets can often lay dormant during times of investment manager appointments, replacements or shifts. Institutions can use ETFs as a cost effective method to keep assets invested in the interim.

Risks and other considerations ETF shareholders are subject to risks similar to those of holders of other diversified portfolios. A primary consideration is that the general level of stock or bond prices may decline, thus affecting the value of an equity or fixed income exchange traded fund, respectively. This is because an equity (or bond) ETF represents interest in a portfolio of stocks (or bonds). When interest rates rise, bond prices generally decline, adversely affecting the value of fixed income ETFs. Moreover, the overall depth and liquidity of the secondary market may also fluctuate.

An exchange traded sector fund may also be adversely affected by the performance of that specific sector or group of industries on which it is based.

International investments may involve risk of capital loss from unfavorable fluctuations in currency values, differences in generally accepted accounting principles, or economic, political instability in other nations.

Although exchange traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the ETFs may not be able to exactly replicate the performance of the indexes because of expenses and other factors.

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