Exchange Traded Funds

The American Stock Exchange: Where ETFs were born, raised, and spend all of their quality time

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As a pioneer in the creation of Exchange Traded Funds (ETFs), the American Stock Exchange launched a whole new class of securities that has grown to $100 billion in assets in less than a decade. Today, the Amex remains the center of development and the global market leader, with more than 100 listed ETFs.

Each ETF is a basket of securities that is designed to generally track an index-broad stock or bond market, stock industry sector, or international stock-yet trades like a single stock. The unique combination of many of the best features of other investments presents financial opportunities for both individual and institutional investors, including:

• Tax efficiency
• Lower costs (Ordinary brokerage commissions apply)
• Transparency
• Buying and selling flexibility
• All day tracking and trading
• Diversification
• A wide array of investment strategies

Exchange traded funds offer individual investors:

• advantages of stocks and mutual funds combined
• lower fees (ordinary brokerage commissions apply)
• lower capital gains taxes

In recent years, these unique features and benefits 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), exchange traded funds have evolved into an entirely new investment category. Now, after 9 years, 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. The Financial Research Corporation predicts total assets in ETFs will reach anywhere between $500 billion to $1 trillion by the year 2007.

What are exchange traded funds?

Exchange traded funds (ETFs) are index funds or trusts that are listed on an exchange and can be traded intraday. Investors can buy or sell shares in the collective performance of an entire stock or bond portfolio as a single security. Exchange traded funds add the flexibility, ease and liquidity of stock trading to the benefits of traditional index fund investing.

The American Stock Exchange lists ETFs on more than 100 broad stock market, stock industry sector, international stock, and U.S. Treasury, and corporate bond indexes, providing a wide array of investment opportunities. ETFs provide a simple and effective way to invest in equity markets worldwide and the U.S. bond market. Investors can establish long-term investments in the market performance of the leading companies in the leading industries in the United States or abroad, or tailor asset allocations using diversified investments in stocks in particular industries or countries or in U.S. bonds.

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
• Core investment
• Portfolio diversification
• Hedging
• Cash management
• Rebalancing
• Tax loss strategy

Tax efficiency

ETFs, like index funds in general, tend to offer greater tax benefits because they generate fewer capital gains due to low turnover of the securities that comprise the portfolio. Generally, an ETF only sells securities to reflect changes in its underlying 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 through exchange trading. Because of this unique structure, ETFs are not required to sell securities to meet investor cash redemptions, potentially generating capital gains tax liability for remaining investors. Keep in mind that the sale of an ETF will generate capital gains/losses for the investor liquidating shares.

Lower costs

Expenses can have a significant impact on returns for investors. ETFs, in general, have significantly lower annual expense ratios than other investment products. ETFs are less likely to experience high management fees because they are index-based, not "actively" managed. And, since they trade on an exchange, ETFs are insulated from the costs of having to buy and sell securities to accommodate shareholder purchases and redemptions. Of course, an investor selling ETF shares may realize capital gains or losses, as with common stocks. Purchases or sales of exchange traded funds are subject to brokerage commissions.

Transparency

ETFs are designed to generally replicate the holdings and correspond to the performance and yield of their underlying index.

Buying and selling flexibility

Because they are exchange traded, ETFs can be:

• bought and sold at intraday market prices
• purchased on margin
• sold short, even on a down tick (unlike common stocks)
• traded using stop orders and limit orders, which allow investors to specify the price points at which they are willing to trade

All day tracking and trading

ETFs are priced and traded throughout the day, and are not restricted to once-a-day trading at the end of the day. And because the pricing of ETFs is continuous during trading hours, investors will always be able to obtain up-to-the-minute share prices from their broker or financial adviser.

Diversification

Because each ETF is comprised of a basket of securities, 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 on 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

Investors can capitalize on the convenience and flexibility of ETFs to pursue a wide variety of investment strategies.

Core investment - Investors can use ETFs as a core investment for their portfolio. The purchase of shares in a single exchange traded fund can provide broad market exposure of a portfolio of stocks or bonds for long-term holding that is easy to establish, easy to track, inexpensive, and tax efficient.

Portfolio diversification - ETFs cover virtually every segment of the equity markets and several segments of the U.S. bond market, providing an easy and convenient way to adjust the investment mix of a core portfolio.

Hedging - Exchange traded funds can be purchased on margin and sold short (even on a down tick), which has opened up risk management strategies for individual investors that were once available only to large institutions. For example, ETFs can be sold short to hedge a core stock portfolio or interest rate fluctuations. This allows investors to keep their portfolio intact while protecting it from market losses. In a declining stock market or rising interest rate environment, profits from a short position can offset some of the losses in a portfolio. (Investors are required to make arrangements to borrow securities before selling short.) Listed options, available on some exchange traded fund products, also offer opportunities for additional hedging or to increase income. Investors should contact their broker regarding initial and maintenance margin requirements.

Cash management - ETFs have often been used to "equitize" cash, providing a way for investors to put cash to work in the market or maintain allocation targets while determining where to invest for the longer term.

Rebalancing - Investors can adjust Exchange traded fund positions at any time throughout the trading day, without redemption fees or short-term restrictions. Again, usual brokerage commissions will apply.

Tax loss strategy - An investor can sell a security that is under performing and claim a tax loss but retain exposure to its sector by investing in an Exchange traded fund. Consult a Financial Planner or tax advisor about a tax loss strategy.

Risks and other considerations

Exchange traded fund 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) Exchange traded fund represents interest in a portfolio of stocks (or bonds). When interest rates rise, bond prices generally will decline, which will adversely affect the value of fixed income Exchange traded funds. 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 trusts may not be able to exactly replicate the performance of the indexes because of trust expenses and other factors.

For a news story on how ETFs can protect YOU from
Mutual Fund Scandal-like activities click here

FAQS

What are exchange traded funds?

Exchange traded funds (ETFs) are index funds or trusts that are listed and traded intraday on an exchange. They let you buy or sell shares in the collective performance of an entire stock or bond portfolio as a single security. Exchange traded funds add the flexibility, ease and liquidity of stock trading to the benefits of traditional index fund investing.

How can I buy or sell exchange traded funds?

You can buy or sell exchange traded funds through a broker, just as you buy stock.

How easily can I buy or sell exchange traded funds?

As easily as you can buy or sell shares of stock. Exchange traded funds are listed on an exchange and can be traded intraday, making it easy for you to buy or sell ETFs.

What is the minimum size purchase of an exchange traded fund?

You can purchase as little as one share.

What are the benefits of exchange traded funds trading as stocks?

The unique "exchange traded" structure offers several advantages to exchange traded fund investors:

• buy and sell at any time during the trading day
• instantly get exposure to a portfolio of stocks or bonds of your choice
• buy on margin
• sell short, even on a down tick
• no sales loads, although brokerage commissions will apply
• lower fees
• tax efficiencies

Why invest in an index?

Indexing, often called "passive management," involves investing in a group of securities that represent the composition of a broad stock market, stock industry sector, international stock, or U.S. bond index. Index funds offer "market level" performance; they aim to generally match the performance of a specific index. Index funds generally have lower management fees and operating expenses than actively managed funds.

How does the performance of an exchange traded fund compare with the performance of its underlying index?

Exchange traded funds are designed to provide investment results that generally correspond to their underlying benchmark index by holding a portfolio of securities designed to give similar price and yield performance. In the secondary market, one mechanism that helps to keep an exchange traded fund trading on the exchange at a price close to the value of its underlying portfolio is arbitrage. Because Exchange traded funds are both created from the securities of an underlying portfolio and can be redeemed into the securities of an underlying portfolio on any day, arbitrage traders may move to profit from any price discrepancies between an Exchange traded fund and the portfolio, which in turn helps to close the price gap between the two. (Exchange traded fund creations and redemptions are restricted to large transactions, typically in multiples of 50,000 shares but ranging from 25,000 to 600,000 shares, usually transacted by large investors and institutions.) Of course, because of the forces of supply and demand and other market factors, there may be times when shares of an exchange traded fund trade at a premium or discount to its underlying portfolio value.

Can exchange traded funds be purchased on margin?

Exchange traded funds may be purchased on margin, subject to the same terms that apply to common stocks. You should contact your broker regarding initial and maintenance margin requirements.

Can exchange traded funds be sold short?

Yes. All Exchange traded funds may be sold short, representing the sale of "borrowed" shares in anticipation of lower prices. Exchange traded funds are exempt from the rule that requires shares to be sold short on a plus or zero plus tick (i.e., a sale price higher than the last different regular way sale in the security). Investors are required to make arrangements to borrow securities before selling short.

Is there a sales load on exchange traded funds?

While exchange traded funds are not subject to sales loads, usual brokerage commissions for securities purchases and sales will apply.

Do I get paid dividends on exchange traded funds?

ETF holders are eligible to receive their pro rata share of dividends, if any, accumulated on the stocks held in an ETF, and interest on the bonds held in an ETF, less fees and expenses. Of course, based on past performance, little, if any, dividend distributions can be expected on certain ETFs. There may also be the opportunity for dividend reinvestment.

Where do exchange traded funds initially come from?

Exchange traded funds are "created" by large investors and institutions in block-sized units of shares (or multiples thereof) known as "Creation Units" of a respective Exchange traded fund. A creation requires a deposit with the trustee for a specified number of shares of a portfolio of securities closely approximating the composition of the specific index and a specific amount of cash in return for shares of a specific Exchange traded fund. Similarly, block-sized units of Exchange traded fund shares can be redeemed in return for a portfolio of securities approximating the index and a specified amount of cash.

Where can I find exchange traded funds listed in the newspaper?

You can find Exchange traded funds listed in the financial section of many newspapers under the heading "American Stock Exchange Listed Stocks." They are also listed under "Exchange Traded Portfolios" in the financial section of The Wall Street Journal.

Is the value of an exchange traded fund equivalent to the value of the underlying index?

Not necessarily. The share price of many Exchange traded funds is initially set at a percentage of the index upon which they are based, but may differ over time due to costs and other factors.

Where can I get up-to-date price information on ETFs?

The pricing of Exchange traded funds is continuous on the American Stock Exchange during normal trading hours. Investors can obtain this information from their brokers, stock quotation systems, or on a delayed basis by clicking here. The closing prices are also published in major newspapers on the following business day.

Where can I get a prospectus?

It is important that you request a prospectus for all Exchange traded funds in which you are interested. A prospectus, which contains more complete information, including charges, expenses and potential risks, can be obtained on a specific Exchange traded fund by clicking here for http://www.amex.com/etf/mktSum/quotesummary/data.jsp. Please read the prospectus carefully before you invest.

What are the risks of investing in ETFs?

Equity-based Exchange traded funds are subject to risks similar to those of stocks; fixed income-based Exchange traded funds are subject to risks similar to those of bonds. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Foreign investments have unique and greater risks than domestic investments. Past performance is no guarantee of future results.

Exchange traded funds are subject to risks similar to those of stocks. Investment returns will fluctuate and are subject to market volatility, so that an investors shares, when redeemed or sold, may be worth more or less than the original cost. Investments in foreign investments may incur greater risks than domestic investments. Past performance is no guarantee of future results.

An investor should consider investment objectives, risks, charges and expenses before investing. To obtain a prospectus, which contains this and other information, call 1-800-THE-AMEX (1-800-843-2639). For First Trust Portofolios the toll-free number is 1-800-621-1675. For all iShares the toll-free number is 1-800-iShares (1-800-474-2737). For Claymore ETFs the toll-free number is 1-800-345-7999. For ProShares the toll-free number is 1-866-PRO-5125. For Rydex ETFs the toll-free number is 1-800207-3390. For all streetTRACKS the toll-free number is 1-866-S-TRACKS (1-866-787-2257). For United States Oil Fund the toll-free number is 1-800-920-0259. For Market Vendor ETFs the toll-free number is 1-888-MKT-VCTR (1-888-658-8287). For Vanguard VIPERS the toll-free number is 1-866-499-VIPER (1-866-499-8473). Read a prospectus carefully before investing.

Fixed Income ETFs FAQs

What are fixed income ETFs?

Fixed income Exchange traded funds are bond index funds that are listed and traded intraday on an exchange. They let you buy or sell shares in the collective performance of an entire bond portfolio as a single security. Exchange traded funds add the flexibility, ease and liquidity of stock trading to the benefits of traditional bond index fund investing.

Why buy fixed income investments?

Diversifying into fixed income investments may provide stability to an equity portfolio because the bond markets are often less volatile than the stock markets.

Do fixed income ETFs pay dividends?

Yes. Dividends, if any, will be distributed on a monthly basis, similar to bond mutual funds.

How will they be taxed?

Dividends paid out of an Exchange traded fund's net investment income and net short-term capital gains, if any, are taxable as ordinary income. Distributions of net long-term capital gains, if any, in excess of any net short-term capital losses, are taxable as long-term capital gains.

Will fixed income ETFs be as tax efficient as equity ETFs?

Because fixed income Exchange traded funds typically have higher yields than equity Exchange traded funds, they may not be as tax efficient. In addition, the deletion of maturing bonds from bond indexes and the addition of newly issued bonds may result in higher turnover rates than equity funds.

As always, this introductory page should not be your only research into Exchange traded Funds. Please see your Financial Advisor for more Information before deciding to employ this Investment strategy.