Exchange Fund

"You give me 18,000 shares of Whatever.com, and I'll give you 312,000 shares of this Exchange Fund." You're exchanging shares in your high risk, one-stock-bet company Whatever.com for shares in a diversified index fund, more or less. With no tax. That's a biggie here.

Why would you want to do this? Well, if you were nervous about having sooooo many eggs in your basket of Whatever.com that you couldn't sleep at night, and you just wanted to take market risk instead of individual stock risk, you'd want to make this exchange happen.

For many company founders, for example, the cost basis on their now-trading-at-$100-a-share stock is like a penny, so they'd pay taxable realized gains of $99.99 a share were they to ever sell that stock. So they exchange it for shares in a fund, rather than just sell and pay the tax.

Related or Semi-related Video

Finance: What Are ETFs?275 Views

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Finance allah shmoop shmoop what are efs Well first this

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is the random financial terms you want to be asked

00:10

in the financial term spelling bee and second you should

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know that e t f stands for exchange traded fund

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f's are kissing cousins of index funds with one key

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subtle but important difference f don't change at least generally

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speaking an index fund might reflect the transportation industry and

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have so much exposure to ford gm united airlines tesla

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etcetera But it's required tohave say sixty five percent of

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its exposure to companies based in the united states in

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its charter every month that index fund has to re

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balanced that exposure So if the auto companies do very

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poorly in a given month index fund has to re

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balance by buying mohr shares of those auto companies to

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make up the difference you know given that they've performed

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poorly relative toa airlines trucking company's railroads jeff howard segways

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and so on But in a t f the fund

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is basically set once and the shares just really kind

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of float if over a decade the auto companies do

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really well then in an e t f the auto

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companies will just have a dominant influence on the overall

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performance of the fund The management company doesn't have to

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buy and sell shares regularly in an e t f

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till fulfill the legal promises it agreed to at the

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outset of the fund in the way in index fund

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re balances its shares by buying and selling them So

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what does that mean to you Well it means that

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fc may drift in given directions like this guy For

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example a generic technology e t f might have had

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a total exposure of say five percent to internet stocks

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in the beginning of nineteen ninety seven but amazon ebay

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yahoo netflix and a well performed massively better than the

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broader technology market which did well but just not omg

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dot com well so that five percent waiting twenty years

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later might be more like fifty percent or mohr of

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that particular e t f but one other key aspect

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of it is that it's traded like a stock i

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e in one block and trade throughout the day there's

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a bid and an ask price The bids are all

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added up and shares in the fund can be bought

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And sold at any time throughout the day Although the

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market sets the price of an f just like it

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does on a stock Well there now you're all ready

02:28

for the financial term spelling bee And they might also

02:31

ask you to spell lipo Yeah you might want to 00:02:33.69 --> [endTime] write that one on your arm

Find other enlightening terms in Shmoop Finance Genius Bar(f)