A New Financial Instrument For the Turkish Capital Markets: Exchange Traded Funds (ETFs)

Cetin Ali Donmez

Istanbul Stock Exchange Review, 2002, vol. 6, issue 23, 15-40

Abstract: In this paper, the Exchange Traded Funds (ETFs) as one of the fastest growing products of the last decade have been covered in detail. This product was introduced to the financial markets in early 1990s and has shown a remarkable success which lead us to believe that the ETFs will make great contribution to the Turkish Capital Markets. Exchange Traded Funds are mainly passive index tracking funds that are traded just like ordinary common stocks, however a very special feature distinguishes them from the classical mutual funds. The ETF shares can be redeemed which means that the investor can deliver the ETF share and get the actual common stocks in the fund. The reverse of this process is also possible. The investor can deliver the stocks in the ETF portfolio and create the ETF share in return. Due to this special feature, the ETFs provide investors the ability to trade the spot index and the price of ETF cannot move outside the arbitrage band. In this paper, the types of ETFs, historical background and their advantages are explained in detail and numerical examples are provided. Using different methods, different hypothetical fund types are constructed and the sources of divergence of prices of the funds and the Istanbul Stock Exchange index are explored. The mechanics of creation/redemption process and arbitrage are explained in detail by well-designed fictitious examples. Moreover, the special cases of dividend payments, stock splits and rights issues are explained with easy to understand examples. In the last section, the necessary amendments in the Turkish regulations are summarized in order for this product to be launched. It is strongly argued that the ETFs which has shown quite rapid progress in other financial markets will draw quite a lot of investors’ interest and will provide new horizons for the market participants. Therefore, it is suggested that the work should be speeded up to introduce this product to the Turkish capital markets as soon as possible.

Date: 2002
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