Related: A Behind the Scenes Look at ETF Trades
If demand for an ETF outstrips supply, the ETF would show a premium to its iNAV. Consequently, a market maker could step in to borrow shares of stock from an underlying benchmark and put them in a trust to form a so-called creation unit of an ETF, which are then sold to the public on the secondary market, alleviating the premium.
On the other hand, if an ETF shows a discount to its iNAV, a market maker can reverse the process and redeem ETF shares for a basket of underlying stocks.
However, there are instances when premiums and discounts may be a normal facet of ETF trades.
For instance, international equity ETFs have persistent premiums and discounts to their NAV since the underlying assets of foreign securities trade during periods that do not overlap with U.S. trading hours. There is no real-time pricing information available for the underlying assets, so the ETFs essentially act as price discovery vehicles.
Related: Investing in What Appears to Be an Illiquid ETF
Additionally, bond ETFs may have more persistent premiums and discounts to NAV since the bond market is inherently less liquid, which limits the ability of market makers to efficiently swap creation units for ETF shares to arbitrage the difference away.