What happens in ETF redemption?

• A. Investors receive cash payout from sponsor
• B. The ETF sponsor creates new shares to the market
• C. The underlying index is reset to match NAV
• D. APs deliver a creation unit to the custodian in exchange for the underlying securities, and the sponsor cancels redeemed shares

Answer: (D)

Redemption is the process where large investors, called authorized participants, remove ETF shares from circulation in exchange for the actual securities the fund holds. In this flow, the AP hands over a creation unit—a big block of ETF shares—to the fund’s custodian and, in return, receives the corresponding basket of underlying securities. The ETF sponsor then cancels the redeemed shares, reducing the total shares outstanding. This in-kind exchange helps keep the ETF’s market price close to its NAV and supports tax efficiency by transferring securities rather than cash. It’s different from creating new shares, where underlying securities go to the fund in exchange for fresh ETF shares, and it’s not about resetting the index. The described process—AP delivering a creation unit to the custodian in exchange for the underlying securities, with the sponsor canceling redeemed shares—captures how redemption works.