Because the underlying securities trade over-the-counter and not on the secondary market like stocks, current prices of these underlying securities may be hard to obtain, which could make it more difficult to quickly identify if an arbitrage opportunity exists. Therefore, a premium or discount may persist in the ETF.
The important thing to remember is that ETFs generally trade close to their fair value, and premiums or discounts tend to be short-lived. However, that's not always the case, so dig deeper before snapping up a fund simply because it's trading at a discount (you may have to sell at a bigger discount).
The basics of premiums and discounts
When the market price of a CEF is above its net asset value (NAV), the fund is said to be trading at a premium. Conversely, when a fund's market price is below NAV, the CEF is trading at a discount.
"At a discount" is a phrase used to describe the practice of selling stocks, or other securities, below their current market value, similar to a sale of goods at a retail establishment.
If the supply of shares exceeds demand, the price is likely to fall to a NAV discount. If demand exceeds supply, the market price of shares is likely to be at a premium above NAV.
In the second edition of this series, we assess premiums (when an ETF is trading at a higher price than its net asset value or NAV) and discounts (when it is trading at a lower price than its NAV).
A trade discount is a reduction in the list price of a product or service. It is typically offered to customers that offer large amounts of repeat business, that purchase product in significantly large quantities, or that are otherwise considered to be important to the seller.
Broadly speaking, if an investment trust is trading on a discount, it reflects slightly lower demand for its shares than there is supply – in other words, there are more marginal sellers than buyers.
Shares of stock in the company you work for can be a good investment if the company is well-run and appears to have a solid future. That's especially true if you're offered a substantial discount off the regular market price, as is often the case.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
The standard deviation of the premiums (discounts) is 15 basis points on average across all domestic ETFs.
First, ETF investments trade on a stock exchange throughout the day, much like ordinary stocks. That immediately, help answer the question of when to buy ETFs. You can buy them through a broker whenever the stock market is open, and generally you pay the same commission rate that you pay to buy stocks.
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
Mutual funds often provide a broader variety and range of investment options when compared with ETFs. While the ETF market in the United States has exploded over the last 20 years, mutual funds still outnumber ETFs.
Cheaper May Not Be Better
And the less you pay for a fund, the more you keep in your pocket—that will always be true. Still, if you are considering jumping from one ETF to another based on lower fees alone, or picking an ETF solely based on expense ratios, you might want to take pause.
If the share price is lower than the NAV per share, the investment trust is trading at a discount. This means the investment trust isn't as popular and the demand for the shares isn't as strong. If the share price and NAV per share are equal, the investment trust is trading 'at par'.
Trade discount benefits
Improves your reputation: Through trade discounts, you can create a positive perception of your company, especially when you offer high-quality products at reduced prices. This allows you to build trust with customers, which may result in increased customer satisfaction and retention rates.
Any or all of these and other factors could cause a fund's shares to trade at a premium. Conversely, a fund may be trading at a discount due to poor fund performance, or low distribution levels relative to peers or to market expectations.
Trade discount is referred to as the discount that is offered by a seller to the buyer of the product in the form of reduction in the price of the item. Trade discounts are offered to increase the sales of the product and make the customers feel that they are getting the best offer.
The amount of trade discount, denoted as 'A', is calculated by multiplying the discount rate, represented by 'd', by the list price, denoted as 'L'. The net price, denoted as 'N', is determined by subtracting the discount amount from the list price.
What is a Trade Discount? A trade discount is the amount by which a manufacturer reduces the retail price of a product when it sells to a reseller, rather than to the end customer.
Since market prices are ruled by supply and demand, an ETF's market price can diverge from its NAV. If there's heavy demand from buyers, the price of an ETF can increase above its NAV (a premium). Conversely, if there's heavy sell-side pressure, the price can dip below the NAV (a discount).
Compare the ETF's Market Price to the NAV
Compare the market price to the NAV to determine if the ETF is trading at a premium or discount to its NAV. If the market price is higher than the NAV, the ETF is trading at a premium. If the NAV is lower than the price, the ETF is trading at a discount.
What is a good expense ratio? Typically, ETFs have lower expense ratios than mutual funds. Generally, low-cost equity ETFs will have a net expense ratio of no more than 0.25%. Low-cost equity mutual funds will have expense ratios of 0.5% or lower.