An exchange traded fund (ETF), specifically a swap exchange traded fund (swap ETF) that is structured to replicate its index with an unfunded swap transaction. The fund owns the assets (substitute basket). The synthetic or indirect replication of the index involves a swap transaction for exchanging a basket’s return (index return) by means of OTC derivatives. The ETF enters into a contract with a financial institution, whereby the latter delivers the index return in exchange for a fee.
Given the use of swap contracts in the ETF construction, the fund is exposed to the counterparty risk involved in the swap (the counterparty risk arises from asset values changing every day).
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