J. Parsons Interview                                                                   Page 2

JW: Does the NSCC regulate to any degree the composition of the ETFs? Do you have to get out of one and in another one to fund composition changes within a certain time period?

JP: Yes, the NSCC has that rule. Basically it's the prospectus filing with the SEC that says that these are index funds that seek to track the return of the underlying index. And as the result of them being a [40-Act] registered investment company, they are managed funds. They are unlike a unit investment trust (UIT) structure, which is considered an unmanaged structure. So that's why we're able to reinvest dividends as opposed to holding them in a non-interest bearing account.

JW: Right, that's the whole angle, that's the tax angle that ETFs have, because it has a different structure from the open-ended in that way, that allows them to reinvest. And also you don't have the distributions issue.

JP: The reinvestment of the underlying securities is really a distinction between the 40-Act fund structure and the unit investment trust structure. A unit investment trust structure cannot reinvest the dividends [in] the underlying securities. So if you look at the "Spider" product, it's underperformed the index by its expense ratio plus about ten basis points. There are actually studies that show that's within a basis point of the exact calculation you'd get if you estimated what the return over that period of a dividend yield not being invested in the index.

JW: And under the registered investment trust company, are there certain limitations in terms such that you can't have one stock that makes up more than 25 percent of the fund?

JP: Right. We have the same diversification and rules that a standard traditional mutual fund would have. So there are two rules, which are also the IRS rules. The first is a quarterly measure of no stock over 25 percent. The second is what's called the 5/50 rule, which is all your holdings that are greater than five percent can't in total add up to more than 50 percent of the fund.

JW: Is that why the iShares in Sweden and Canada had to do a big distribution, because they had to re-balance?

JP: Re-balance to meet the diversification rules. Correct.

And also you'll see, in some of the funds, we'll run them as an optimized fund. Because, for instance, in the Dow Jones Energy Fund, Exxon represents some 43 percent of the total index. And we certainly don't want to buy up to 43 percent and sell down to 25 percent, buy up to 43, sell down, and buy up again, right? That turnover is just unacceptable.

So we'll run an optimized portfolio to keep the weights closer to 25 percent and still track the return of the underlying index.

Glossary of Terms

Market Maker: An options exchange member who trades for his or her own account risk and is charged with the responsibility of trading so as to maintain a fair, orderly, and competitive market.

National Securities Clearing Corporation (NSCC): Organization responsible for arranging a daily clearance of transactions for members by means of a continuous net settlement process.

Depository Trust Company (DTC): An independent corporation owned by broker/dealers and banks responsible for holding deposit securities owned by broker/dealers and banking institutions; arranging the receipt and delivery of securities between users by means debiting and crediting their respective accounts; and arranging for payment of monies between users in the settlement of transactions.

Unit investment trust (UIT): a "basket" that allows investors to directly own the underlying stocks in their portfolio.

10/19/2000

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