EXECUTIVE SUMMARY

Exchange Traded Funds (ETFs) are mutual fund units which investors buy/sell from the stock exchange, as against a normal mutual fund unit, where the investor buys /sells through a distributor or directly from the AMC. Practically any asset class can be used to create ETFs.Globally there are ETFs on Silver, Gold, and Indices. Gold ETFs are a special type of ETF which invests in Gold and Gold related units. Investors can buy G-ETF units from secondary markets either from the quantity being sold by the APs or by other retail investors. Retail investors canal so sell their units in the market. Exchange Traded Funds (ETFs) are open ended mutual funds that are passively managed and most of them seek to mirror the return of an index, a commodity or a basket of assets. ETFs are listed and traded on stock exchanges like stocks. They enable investors to gain broad exposure to indices or defined underlying asset (commodity) with relative case, on a real-time basis, and at a lower cost than many other forms of investing. Gold backed Exchange Traded Funds (ETFs) are units designed accurately to track the gold price. ETF liquidity is supported by large professional market makers and dealers, in the normal way of providing liquidity on the relevant stock exchange. Additionally there is the facility to create and redeem new units -- on demand.

INTRODUCTION ETFs are just what their name implies: baskets of units that are traded, like individual stocks, on an exchange. Unlike regular open-end mutual funds, ETFs can be bought and sold throughout the trading day like any stock. Most ETFs charge lower annual expenses than index mutual funds. However, as with stocks, one must pay a brokerage to buy and sell ETF units, which can be a significant drawback for those who trade frequently or invest regular sums of money. Exchange Traded Funds (ETFs) are open ended mutual funds that are passively managed and most of them seek to mirror the return of an index, a commodity or a basket of assets. ETFs are listed and traded on stock exchanges like stocks. They enable investors to gain broad exposure to indices or defined underlying asset (commodity) with relative case, on a real-time basis, and at a lower cost than many other forms of investing. Gold ETFs provided investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that participation through the trading of units on stock exchange. Gold ETF would be a passive investment; so, when gold prices move up, the ETF appreciates and when gold prices move down, the ETF loses value. Gold ETF tracks the performance of Gold Bullion. Gold ETFs provide returns that, before expenses, closely correspond to the returns provided by physical Gold. Each unit is approximately equal to the price of 1 gram of Gold. But, there are Gold ETFs which also provide a unit which is approximately equal to the price of gram of Gold. They first came into existence in the USA in 1993. It took several years for them to attract public interest. But once they did, the volumes took off with a vengeance. Over the last few years more than $120 billion(as on June 2002) is invested in about 230 ETFs. About 60% of trading volumes on the American Stock Exchange are from ETFs. The most popular ETFs are QQQs (Cubes) based on the Nasdaq-100 Index, SPDRs (Spiders) based on the S&P 500 Index, is HARES based on MSCIIndices and TRAHK (Tracks) based on the Hang Seng Index. The average daily trading volume in QQQ is around 89 million shares. Their passive nature is a necessity: the funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values of their underlying portfolios. For the mechanism to work, potential arbitragers need to have full, timely knowledge of a fund's holdings. Both retail and institutional investors have found ETFs to be excellent investment vehicles. Across all types of investors, there are a number of key characteristics that make ETFs attractive, most notably:

Continuous, Intraday Pricing : In sharp contrast to traditional mutual funds, ETFs trade on exchanges throughout the day. As a result, pricing is continuously updated. On many exchanges, pricing is available in bonds.

Access to indicators and Indexes : Since each ETF share represents a fraction of a basket of units, ETFs provide simple, low-cost access to numerous indicators and industries (e.g., Telecommunications), as well as popular indexes (e.g., S&P 500). ETFs also provide many opportunities for style investing growth, value, core, etc.

Ability to Track an Entire Market Segment : The core guiding principle of an ETF fund manager is to track the underlying index as closely as possible. As a result, ETFs provide investors with a simple, transparent and accurate means of tracking a complete market segment.

Diversity in Investment Opportunities : Managing around the fate of single stocks is an important part of many individual and institutional investment strategies. ETFs, through their expansive underlying basket of units, allow instant portfolio diversification.

Low Expense Ratios : Unlike actively managed mutual funds that charge high fees for fund manager expertise, marketing, and high levels of fund retooling, ETFs inherently have low expense ratios because of limited fund manager decisionmaking.

Tax Efficiency : In the U.S., the most successful ETFs provide excellent tax efficiency through low turnover rates, as well as the unique in-kind creation and redemption process that shields investors from capital gains associated with cashouts.

Transparency : ETFs demonstrate a high level of transparency because they are based on well-published fund holdings these are most commonly a basket of equities that track an index.

Equalize Cash : Both institutional and retail investors find ETFs to be a low-cost option for parking excess cash in the broad stock market. Portfolio Risk Management : Unlike traditional mutual funds, ETFs support market, limit, and short trading, as well as derivative products such as options and futures.

ETF: The Concept An Exchange Traded Fund, as the name itself suggests; is a financial instrument, tradable on a stock exchange, that invests in the stocks of an index in approximately the same proportion as held in the index. An ETF is a hybrid financial product, a cross between a stock and a mutual fund. Like a stock it can be traded on a stock exchange, and like a mutual fund it behaves like diversified portfolio. In many ways it is an index fund, with a few subtleties that put it in a separate league. Unlike an open-ended index fund, where an investor purchases units from the fund itself and to redeem them sells the units back to the fund and thereby expanding or shrinking its corpus on each entry or exit from the fund, in an ETF is listed on an exchange ensuring that the entry or exit of investors has no effect on the fund corpus. An ETF is transacted through a broker and held in dematerialized form. An ETF is different from an Index Fund in another manner. Availability of real-time quotes is another feature present in an ETF but absent in an Index Fund where the previous days NAV is applied for buying or redeeming. This feature makes the trading of the ETFs possible. Much like the units of a mutual fund the ETF too, is divided into units called a "creation unit". The name emanates probably from the process through which one comes to acquire these units. The ETF units when purchased from the fund house are purchased by surrendering the underlying stocks in of the index the ETF tracks and thereby 'creating' the ETF unit. In short, they are similar to index mutual funds, but are traded more like a stock. As their name implies, Exchange Traded Funds (ETFs) represent a basket of unities that are traded on an exchange. An ETF is a hybrid financial product, a cross between a stock and mutual fund. Like a stock it can be traded on a stock exchange, and like a mutual fund it behaves like a diversified portfolio. Unlike an open ended index fund, where an investor purchases units from the fund itself and to redeem them sells the units back to the fund and thereby expanding or shrinking its corpus on each entry or exit from the fund, in an ETF is listed on an exchange ensuring that the entry or exit of investors has no effect on the fund corpus. An ETF is a combination of an open-end and a close-end fund. Like any open-end fund, you can buy units with the fund. But there is a difference. In an open-end fund, you will pay cash to buy units. In the case of an ETF, you are required to provide the underlying shares to buy the units. If the demand of the ETFs in the markets soars, the ETF would start trading at a premium from its intrinsic value, which should be equal in proportion to the index that it is charting. This premium would make the buyers go to the fund house where they would have to redeem their shares in the proportion held under each unit of the ETF. In case of redemption in the

market, the seller would get paid in cash and in case the fund units are taken to the issuer, the seller would get paid in kind that is the underlying shares that make up the index. ETF trading also opens up the flood gates for some more complex trading arrangements like arbitrage between the cash and futures market or simply put - short selling. But there is a hitch as far as the Indian capital markets is concerned: "shorting" is not allowed. An ETF is basically created through an initial public offering (IPO) by the Asset management companies in which only authorized participants (Aps), institutions, large investors are allowed to participate. These investors exchange their portfolio of stocks and a cash component for ETFsalso known as creation units. These creation units are made of two components namely portfolio deposit and cash component. Portfolio deposit consists of basket of shares that make up an index and the cash component is the difference between the applicable NAV and the market value of the portfolio deposit, which arises mainly due to transaction costs, rounding of shares and incidental expenses involved. These units can be either held as investments or sold in the market to the retail investors. ETFs can be also sold back to the mutual fund company but mutual funds buy it at a heavy discount to encourage their selling on the exchanges. The net asset value (NAV) of an ETF is the value of the underlying components of the benchmark index
held by the ETF,plus the accrued dividends, less the accrued management fee.

TYPES OF ETF IN INDIA EQUITY BASED Nifty BeEs: This is an index ETF that tracks the Nifty, which means that it holds the stocks in the same proportion as they are present in the Nifty index. It has an expense ratio of 0.50% as on29th May 2009. Kotak PSU Bank ETF: This is an index ETF that aims to provide returns corresponding to the CNX PSU Index. It has an expense ratio of 0.65%. Reliance Bank Exchange Traded Fund: This is an index ETF that tracks the CNX bank index. It has an expense ratio of 0.80% up to Rs. 500 crore of assets, and 0.70% beyond that. Quantum Index Fund QNIFTY ETF: This is an index ETF that tracks the performance of the CNX Nifty. It has an expense ratio of 0.75%.

How ETFs are traded The trading of the ETF is based on a well-known mechanism called arbitrage. But first, let us seehow one can buy an ETF. There are two ways in which one can buy an ETF. One is through the market and the other is through the fund house that has issued the ETF. Now for the pricingmechanism: if the demand of the ETFs in the markets soars, the ETF would start trading at apremium from its intrinsic value, which should be equal in proportion to the index that it ischarting. This premium would make the buyers go to the fund house where they would have toredeem their shares in the proportion held under each unit of the ETF. Such units that are boughtdirectly from the fund house are called "creation units". But usually the lot size in which one canbuy creation units is so high that only an authorized participant (market maker) or institutionalinvestors may have the wherewithal to buy these. In such case the retail investor would have togo to the market itself to buy the units of the ETF, the decision in turn depending on theexpectations of the future price movements of the ETF. In case of redemption in the market, theseller would get paid in cash and in case the fund units are taken to the issuer, the seller wouldget paid in kind that is the underlying shares that make up the index. ETF trading also opens upthe flood gates for some more complex trading arrangements like arbitrage between the cash andfutures market or simply put - short selling. But there is a hitch as far as the Indian capitalmarkets is concerned: "shorting" is not allowed. As a proxy, one can borrow the units but thatmechanism is not very efficient, as the cost of borrowing happens to range between 12 to 18 per cent depending on one's creditworthiness. Given below is a chart that explains the tradingmechanism. Structure of ETF

ETFs offer public investors an undivided interest in a pool of units and other assets and thus aresimilar in many ways to traditional mutual funds, except that shares in an ETF can be bought andsold throughout the day like stocks on a units exchange through a broker-dealer. Unliketraditional mutual funds, ETFs do not sell or redeem their individual shares at net asset value, or NAV. Instead, financial institutions purchase and redeem ETF shares directly from the ETF, butonly in large blocks, varying in size by ETF from 25,000 to 200,000 shares, called "creationunits". Purchases and redemptions of the creation units generally are in kind, with theinstitutional investor contributing or receiving a basket of units of the same type and

proportionheld by the ETF, although some ETFs may require or permit a purchasing or redeemingshareholder to substitute cash for some or all of the units in the basket of assets. The ability to purchase and redeem creation units gives ETFs an arbitrage mechanism intendedto minimize the potential deviation between the market price and the net asset value of ETFshares. Existing ETFs have transparent portfolios, so institutional investors will know exactlywhat portfolio assets they must assemble if they wish to purchase a creation unit, and theexchange disseminates the updated net asset value of the shares throughout the trading day,typically at 15-ond intervals. Most ETFs are structured as open-end management investment companies (the same structureused by mutual funds and money market funds), although a few ETFs, including some of thelargest ones, are structured as unit investment trusts. ETFs structured as open-end funds havegreater flexibility in constructing a portfolio and are not prohibited from participating in uritieslending programs or from using futures and options in achieving their investment objectives.Either is an index fund, or discloses each business day on its publicly available web site theidentities and weighting of the component units and other assets held by the fund