UBS ETFs are basically financial instruments with superior liquidity. In the case of UBS ETFs, liquidity is guaranteed by multiple market makers that commit to continuously quote buying and selling prices for a specific minimum volume during trading hours. The resulting competition ensures that bid and ask prices are close to each other, thereby keeping the spread to a minimum.
What are the two types of liquidity?
ETFs offer two forms of liquidity:
- In the first type, liquidity is generated by trading volumes on the stock exchange (secondary market)
- In the second, liquidity is provided by the creation and redemption of ETF units on the primary market. The latter is referred to as the creation/redemption process.
What is the creation/redemption process?
The creation/redemption process is the exchange of ETF units between the ETF and a market maker or authorized partner in return for cash or securities. When ETF units are issued (creation), market makers or authorized partners deliver either a basket of securities or cash to the ETF and receive in return the corresponding amount of ETF units, which they then make available on the secondary market for trading.
By contrast, when ETF units are redeemed, the market makers or authorized partners return a fixed number of ETF units to the ETF in exchange for either a corresponding basket of securities or else cash. In this way, new units can be created as demand increases or, by contrast, existing ETF units can be redeemed as demand decreases. Consequently, the ETF reflects the value of the security it tracks.
ETF trading in the secondary and primary market
Secondary market: Trading of existing ETF units among ETF investors, banks, brokers and exchanges
Primary market: Subscription/redemption of ETF units between authorized participants and the ETF (fund)