Question

1. Define the following terms :
   1. spiders
   2. mutual fund
   3. net asset value
   4. counterparty risk
2. What is meant by financial innovation? Identify and explain the main forces that motivate the search for financial innovations.
3. What are exchange-traded funds (EFTs)?
   1. What was the first ETF?
   2. What was the first example of an ETF innovated in the United States?
4. How does a closed-end mutual fund differ from an open-end fund?
   1. What advantages and disadvantages does each type of mutual fund have?
   2. What advantages of ETFs relative to both types of mutual funds explain ETFs rapid growth?
   3. How does Amaral use the data on corporate bond spreads to distinguish alternative explanations for the sharp credit downturn? What does he conclude? Why?

Answer 1

1. a) Spiders were the first ETFs launched in USA under the ticker SPDR. They are still actively traded in USA. They track and match the performance of index.

b) Mutual funds pool investors funds and allocate funds in stocks, bonds and other securities by paying security fees and other expenses. They create different funds based on the risk and return appetite of the investor.

c)NAV (Net Asset Value) : The excess of assets over liabilities divided by the total no of shares. It is the total value of assets in ETFs and Mutual funds.

d) Counterparty Risks: The risks associated when a party does not meet its contractual obligations. Bonds with higher counter party risk have higher interest rate as compared to lower counter party risks. Miscalculation in counter party risk is one of the reasons of the economic recession of 2008.

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