An exchange-traded fund (ETF) is a security that tracks an index but has the flexibility of trading like a stock. Just like an index fund, an ETF represents a basket of stocks that reflects an index. The difference is that an ETF isn't a mutual fund - it trades just like any other company on a stock exchange. The high management fees and the lack of liquidity of index mutual funds have made ETFs increasingly popular investment vehicles. Almost every one of today's major indexes has an ETF tracking its performance, and most ETFs are passively managed by some form of trust company. These trust companies take on the responsibility of maintaining the portfolio of stocks within the index to which they are linked. The trust company transforms the portfolio into individual shares of ETFs, which are then sold and purchased on the AMEX like regular stocks, such as the Spiders and Diamonds ETFs.

Even though ETFs are passively managed and mimic a specific index, charges are incurred for these services. These charges are typically lower than those of index funds and are used for day-to-day operations, maintenance of the index portfolio, and payment of employee salaries. Part of the maintenance of the portfolio entails the collection and safekeeping of dividends paid by companies within the index portfolio. It is the duty of the trust companies to distribute these payments to the ETF stockholders; the distributions are normally made on a periodic basis.

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  3. Does index trading increase market vulnerability?

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  4. What does a high turnover ratio signify for an investment fund?

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  5. What is the difference between passive and active asset management?

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