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Bond ETFs & Interest Rates

Market Measures

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Economists have been predicting a rise in interests rates for a while, and despite being wrong recently, eventually they will be right (unless they change their minds in the interim). What would happen to the various Bond ETFs once interest rates rise?

An ETF is an Exchange Traded Fund and like other Bond Funds, a Bond ETF has no maturity or coupon. It is made up of multiple bonds that together fit the stated makeup of the fund. To keep things in line, bonds must be bought and sold and the fund changes in value as the bonds within the fund fluctuate in value.

An example is the iShares 20+ Year Treasury Bond ETF (TLT). TLT holds bonds that have maturities greater than 20 years. As the bonds get under 20 years, it sells them and “rolls” to another bond with the desired maturity. Since yields have decreased over the past 10 years, the ETF has performed well since bond prices move inversely to their yields.

There is an inverse relationship between TLT and 30-year yields. Small changes in the yield of the 30-year Bond can result in large changes to the price of TLT.

Luckily, we can use a formula to approximate price in TLT based on a given yield on the 30-year. The formula was created using a regression of 2 years of data of yields and prices. To place yields in context, we charted a 12 year graph comparing the yields of the 30-year, 20-year, 10-year, 5-year, 1-year and 3-month Treasuries (note that this is not the yield curve).

Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the valuable takeaways, the formula to approximate TLT prices based on 30-year yields and to get a better understanding of the relationship between Bond ETFs and interest rates.

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