Essays on Innovations in Financial Products Case Study

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The paper 'Innovations in Financial Products' is a great example of a Macro and Microeconomics Case Study. One of the benchmarks of market development in the bourse is innovation. An example of fairly recent innovation originates from the mutual fund sector; the inception of exchange-traded funds (ETF). The novelty with ETFs is that although they lay claim to similar fundamental capital as the more mainstream open-end mutual funds, they have a different framework and therefore varied character and outcomes for those who invest in them. ETFs and other innovations are produced in order to snare some elements of the competitive market and barring the expense involved in their development, they represent a considerable benefit to the investor.

This is due to their value addition that fosters greater liquidity, facilitates trade, and brings about the possibility for hedging and arbitrage amongst other services (Agapova, 2006). The Exchange-traded fund can be defined as a combined asset medium whose aim is to reflect the performance of a particular index and is traded as a solitary stock. This implies that it fuses the benefits of diversification inherent to an index tracking fund with the liquidity advantages of trading singular shares.

ETFs generally follow the doings of a commodity index, stock, or bond. As it is with individual stock, ETFs also possess a ticker, SEDOL, and ISIN number. It is also traded on the Exchange. ETFs first came to light in the nineties, with the pioneer being based on the American S& P500 index. From here, it is estimated by Morgan Stanley that ETFs worldwide under management will exceed US$2 trillion by the end of this year (Selftrade, 2008). The Exchange-traded funds are enjoying phenomenal universal success and gain continued popularity due to its rapid proliferation.

There was a 22% drop in Asset under Management (AUM) in Europe in 2008; this contrasts with the AUM for ETFs which rose by 23% in the same period according to the 2009 Barclays Global Investors ETF Industry Preview. The volumes of ETFs traded are also on the increase. The London Stock Exchange has seen the value of ETFs traded rise by 80% since 2007 while the number traded has recorded a two-fold increase according to data from the 2009 London Stock Exchange Monthly Trading Volume.

Demand for ETFs could be ascribed to their affordability, convenience, flexibility, miscellany, intelligibility, and liquidity. All these are seen as crucial attributes of any investment portfolio. There is a wide range of available literature on the more mainstream mutual funds which address various factors in the sector including management, framework, and performance (Elton et al (1993); Sirri & Tufano (1998). By contrast, very little data is on hand on ETFs. This is due mainly to the limited length of time that they have been in existence.

The original mutual fund was incepted in the 1940s, with increased acceptance and usage recorded from the 1970s. The ETFs on the other hand was first created in 1993, although there has been rapid growth and proliferation amongst investors in recent years.   The Origin of Exchange-Traded Funds In a paper written by Hakansson (1976), a hypothetical “ Purchasing Power Fund” predicted an innovative financial medium composed of “ Super shares” that reproduce a dividend only at pre-designated points of the market return. The fundamental capital of the Purchasing Power Fund was identified as index funds.


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