(a) Passive management: targets the profit of the trading index.

　 ETF furthers the role of the index as a benchmark to that of the trading target. Professional financial institutions are responsible for the management of the stocks that constitute the index of which movement directly reflects the changes in the value of the beneficiary certificates. By investing in ETF, investors are able to track the performance of the index and gain the reward related to the movement of the index. Whereas regular funds pursue the goal of beating the market, the ETF imitates the performance of the index and targets on tracking relative movement between net worth and the index. Therefore, under the concept of passive management, the only scenario for adjusting the constituents and weights of the portfolio is located in the changes of the constituents and weights of the index.

(b) Unique mechanism of in-kind creation and redemption

　 Since ETF is of securitized index, the physical assets of ETF are the index basket, which tracks the index. The in-kind creation of ETF is given to the index basket in exchange for a specific amount of ETF, while the in-kind redemption of ETF is given a specific amount of ETF in exchange for the index basket. This specific amount is the standard of the creation and redemption unit. The issuers of ETF set up the unit of creation and redemption, and publish the portfolio composition file (PCF) daily. Creation and redemption are executed only in single or multiples of the standard unit, in physical stocks, and by participating dealers (PD).

　 The unique in-kind creation and redemption mechanism improves the phenomenon of appreciation and depreciation. In the process of creation, when the price of ETF in the secondary market is higher than the net assets value (NAV), there is an appreciation. Institutional investors are able to buy the index basket in the secondary market, and at the same time sell their ETF; they employ the index basket to create ETF at the primary market, clearing the settlement of the ETF sold on the same day and gaining the arbitrage. The fact that institutional investors sell the ETF at the secondary market lowers the price of the ETF, minimizes the range of appreciation, and indirectly curtails the gap between market price and the NAV of the ETF.
As for redemption, when the price of the ETF in the secondary market is lower than NAV, there is depreciation. Institutional investors are able to buy the ETF, and at the same time sell the index basket in the secondary market; they redeem the ETF and obtain the index basket at the primary market, clearing the settlement of the index basket sold on the same day and gaining the arbitrage. The fact that institutional investors buy the ETF stimulates the price of the ETF, minimizes the range of depreciation, and indirectly curtails the gap between the market price and the NAV of the ETF.

　 The process of creation and redemption of the ETF, and the relationship between market prices and the net value of the ETF are illustrated below.

(c) A product comprises the features of both stock and index fund

　 In general, stocks and close-end funds are traded mainly in the secondary market, and open-end funds are bought or sold through fund companies in the primary market, regarding the net value. Whereas ETF is composed of both the features of stocks and open-ended index funds, and traded in both primary and secondary markets. The similarity between ETF and stocks is that ETF can be listed in the stock exchange and traded in margin. The process of creation and redemption of ETF is similar to that of the open-end funds. Generally speaking, the creation and redemption of ETF are executed in a board lot, and in physical stocks, rather than cash. Furthermore, the management fee is much less than that of traditional stock funds.

In summary, all the merits listed above lead to the popularity of the ETF.