The ETFs, Redemptions and Creation Arbitrages Case

 ETF redemption arbitrage

I teach derivatives with John Hull’s Options, Futures, and Other Derivatives, I try to translate the book language into cases pertaining to financial and commodity trading.

These cases are indeed hugely popular among students but aren’t intended to “bridge the gap between the classroom and the trading room” as you may think.

There’s more !

In finance, good numeracy skills are critical to reduce the risk of making bad investment-related decisions because of an inaccurate perception of the information.

In fact, what these cases are really only an excuse…

They are an excuse in a sense that they help the students acquiring a well-honed sense of proportions through numerical problems solving.

With the Location Arbitrage case, I have introduced students to risks and opportunities associated with the concept of ‘arbitrages’.

With the “Redemptions and Creation Arbitrages case”, they were introduced to the math of arbitrages in financial products.

ETFs (exchange-traded funds)

Hedge funds and Institutions will sometimes achieve their strategy in the ETF markets rather than in primary markets when they can find better liquidity in the former.

ETFs have overtaken hedge funds in terms of total assets.[1]

In China’s decreasing margin debt and those ETFs, FT Alphaville has asked the fundamental question:

“Is about now a good time to start asking who the ETFs’ authorised participants are ?” [2]

 

D-bank

Goldman Sachs Asset Management provides a part of the answer.

According to the New-York IB, ETFs allow arbitrageurs to create and redeem units through the in-kind creation / redemption mechanism.

Such arbitrageurs are always in the market to take advantage of any significant.

premium or discount between the ETF market price and its NAV by doing arbitrage between the ETF and its underlying portfolio.

Thus, the open architecture of ETFs ensures that there is no significant premium or discount to NAV.

At the same time, additional demand / supply is absorbed due to the action of the arbitrageurs. [3]

Canadian Gold Reserves

The Canadian Gold Reserves exchange traded receipt (ETR) MNT is an ETR (exchange-traded receipt) incorporated in Canada sponsored by the Royal Canadian Mint. [4]

The ETRs are represented by fully registered, book-based gold ETR certificate with the Canadian Gold Reserves (the “Gold ETR Certificate”).

gold redemptions abitrages

Students were asked to study and particurly pay attention to:

The Characteristics of  MNT.

  • The Economic Pricing relationships between the LBMA, ETRs and its NAV.

  • Redemption and Creation Arbitrages.

  • Current Arb practibility for an Arbitrageur.

  • A critical discussion about the Risks in these strategies.

They have kindly accepted to publish their work on Navigating the commodity markets with Freight and Spreads.


Alain and Alex are MBA Finance Candidates.

An interesting fact is that they also both play very strong on the power play ! [5]

Alex Saulnier
Center
Born Aug 31 1992  -- Moncton, NB 
Height 5.11 -- Weight 191 -- Shoots L


                                            --- Regular Season ---  ---- Playoffs ----
Season   Team                        Lge    GP    G    A  Pts  PIM  GP   G   A Pts PIM
--------------------------------------------------------------------------------------
2009-10  Moncton Wildcats            QMJHL  56    8   10   18    6  21   2   4   6   2
2010-11  Moncton Wildcats            QMJHL  65   25   60   85    8   5   1   4   5   4
2011-12  Moncton Wildcats            QMJHL  58   31   52   83   31  --  --  --  --  --
2012-13  Moncton Wildcats            QMJHL  68   28   54   82   36   5   4   3   7   6
2013-14  U. of Moncton               AUS    28    8   20   28    6
2014-15  U. of Moncton               AUS    28   10   20   30   16


Allain Saulnier
Right Wing
Born Aug 31 1992  -- Moncton, NB 
Height 5.11 -- Weight 190 -- Shoots R


                                            --- Regular Season ---  ---- Playoffs ----
Season   Team                        Lge    GP    G    A  Pts  PIM  GP   G   A Pts PIM
--------------------------------------------------------------------------------------
2009-10  Moncton Wildcats            QMJHL  57    8    9   17   18  21   3   6   9   2
2010-11  Moncton Wildcats            QMJHL  68   31   40   71   48   5   3   1   4   0
2011-12  Moncton Wildcats            QMJHL  66   30   49   79   30   4   0   6   6   6
2012-13  Moncton Wildcats            QMJHL  66   27   56   83   18   5   0   5   5   2
2013-14  U. of Moncton               AUS    28   12   21   33    6
2014-15  U. of Moncton               AUS    28   14   20   34   20
-----------------------------------------------------------------------
source http://www.hockeydb.com

and they can score in Finance too…

The English translation is available on demand. Keep reading as we may publish other works this Fall

Sources:

[1] Bloomberg

[2] FT Alphaville : “China’s decreasing margin debt and those ETFs”, http://ftalphaville.ft.com/2015/07/14/2134402/chinas-decreasing-margin-debt-and-those-etfs/  

[3] Goldman Sachs Asset Management, “ETF Basics”

[4] Royal Mint

[5] According to Hockey DB, the most comprehensive hockey statistics database !

© 2015 Navigating the commodity markets with Freight and Spreads

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One thought on “The ETFs, Redemptions and Creation Arbitrages Case

  1. Pingback: L’Or présente t-il une Possibilité d’Arbitrage. | Blue and Gold Merchants' Club

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