Portfolio Management: An Overview: practice question
An authorized participant delivers to the Bramwell Index ETF a basket of securities worth $3,060,000, assembled at the fund's net asset value per share of $30.60, and receives 100,000 newly created shares. The ETF's shares currently trade at $30.92. The authorized participant immediately sells all 100,000 shares in the market, paying $2,100 of commissions and $1,800 of bid–ask spread costs. The arbitrage profit is closest to:
- $28,100
- $29,900
- $32,000
Show answer and explanation
Correct answer: A
Working: Gross gain = 100,000 × (30.92 − 30.60) = 32,000; total costs = 2,100 + 1,800 = 3,900; net profit = 32,000 − 3,900 = 28,100
Explanation: A is correct. The authorized participant acquires shares at net asset value (3,060,000 / 100,000 = 30.60) and sells them at 30.92, a gross gain of 100,000 × 0.32 = 32,000; deducting total trading costs of 2,100 + 1,800 = 3,900 leaves 28,100. B is incorrect because 29,900 subtracts only the 2,100 of commissions and overlooks the 1,800 bid–ask cost of executing the sale. C is incorrect because 32,000 is the gross price spread and ignores the transaction costs the authorized participant must pay to assemble the basket and sell the shares.
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