The economic relevance as well as all the financial market mechanics that underpin ETFs

Many exchange traded funds (ETFs) track the return of the financial stock market index. They achieve this by holding an underlying basket of the stocks traded in financial markets. Exchange traded funds can be divided into physical and synthetic ETFs where physical ETFs closely track the return of their benchmark index while synthetic ETFs track the index by entering into derivatives contracts such as total return swaps on the benchmark index (David, Franzoni and Moussawi et al 2017:171). The shares of an exchange traded fund can be bought through a brokerage firm from the stock exchange but institutional investors can purchase the shares directly from the fund company (Philips et al. 2008). 

When someone wants to buy the shares, no new shares are created but instead the shares come from someone who also owns the shares in the fund and is willing to sell a fraction (Philips et al. 2008).   These individuals who are willing to sell a portion of their shares are institutional investors and the shares come from what is called the creation unit (Philips et al. 2008).   This structure of exchange traded funds helps keep the administrative costs down while improving operational efficiency (Philips et al. 2008).   

In some countries like the US, exchange traded funds are not allowed to advertise their products as open-ended mutual funds even though they are legally registered as mutual funds because in general investors do not deal directly with the fund companies (Philips et al. 2008). Unlike open ended mutual funds who are priced per day at their closing net asset value, exchange traded funds are continuously priced during the day when the market is open (Philips et al. 2008).  The fund net asset value is what is left after subtracting the liabilities from the assets.

The continuously changing price of an exchange traded fund is typically adjusted every 15 seconds and this price is an estimate of the net asset value per share of a fund (Philips et al. 2008). As the result of the changing prices, the exchange traded funds typically trade at premium or discount to their intraday changing price (Philips et al. 2008).  The settlement date for exchange traded funds is three days meaning if someone buys shares, they must pay within the next three business days but it takes only two business days to receive the payment for selling shares.

When indexing was developed the focus was on reducing the unnecessary costs that are the enemies of good investment performance (Gastineau et al. 2010). The first index fund was not based on an index but instead it was based on owning a portfolio containing an equal dollar amount of each of the 1,500 or so stocks listed
on the New York Stock Exchange, which seemed the most appropriate
replication of ‘the market (Gastineau et al. 2010). Indexing is a form of passive investment which in general provides instead of demanding liquidity. This is not the case for most low fee index funds but instead its mostly hedge funds who employ this strategy (Gastineau et al. 2010).