Posted on 25 October 2011.
Many investors view a rise in interest rates as an opportunity to shift money from stocks to bonds to take advantage of the higher interest rates that bonds pay as interest rates rise. However, there actually is a way that investors and traders can make money from a rise in interest rates, thanks to bearish (inverse) Exchange Traded Funds (ETFs) that are valued based upon the price of long term United States Treasury Bonds.
Bullish ETFs that derive their value based on the price of long term United States Treasury Bonds can be utilized to make money as interest rates fall; however, since interest rates are currently very low, the next interest move that investors should position themselves to make money from is a rise in interest rates. When the rise in interest rates will occur is unknown, and will depend largely on the health of the economy. Strong economic growth in the future will lead to higher interest rates.
A bearish ETF that allows an investor to make money on a rise in interest rates in long term (twenty years and greater) United States Treasury Bonds is the ProShares Short 20+ Year Treasury (TBF). TBF invests in derivatives and money market instruments that are designed to move in a 100% opposite direction of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index, which is a bond index that tracks all publicly-issued United States Treasury securities with: a remaining maturity of greater than or equal to 20 years, $250 million or more of outstanding face value, and an investment grade rating.
For investors who have strong convictions that interest rates in long term United States Treasury Bonds are going to rise and want to make money on the expected rise in interest rates, there are two leveraged bearish ETFs that are designed to return two times (200%) and three times (300%) the opposite direction of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index. These bearish United States treasuries ETFs are the double-leveraged ProShares UltraShort 20+ Treasury (TBT) and the triple-leveraged Direxion Daily 20+ Year Treasury Bear 3X Shares (TMV).
Investors need to understand that TBT and TMV are leveraged ETFs that are designed to make twice and three times the move in the opposite direction of the Barclays Capital 20+ Year U.S. Treasury Bond Index. While leveraged ETFs, such as TBT and TMV, can be a highly effective and profitable way to make money from a rise in interest rates, the risks of holding leveraged ETFs need to be understood.
The most immediate risk is that interest rates move in the opposite direction than expected, which in this case means interest rates fall, and the loss in value of an investment made in the leveraged ETFs is increased by the amount of leverage. A longer term risk is the potential for price decay that can erode the value of leveraged ETFs, due to ETF fees and internal fund rollover costs, as the ETFs sell and buy derivatives and market instruments to maintain their short position in the long term United States Treasury Bonds market. However, in the current market environment, with long term United States Treasury Bonds at historic lows, the risks associated with holding bearish leveraged long term United States Treasury Bonds ETFs, such as TBT and TMV, is exceptionally low.
The one thing every investor can rely on is that eventually the market environment will change, as the economy changes. At some point in the future, the opportunity to make money on a rise in interest rates will have passed until the next economic downturn takes hold.
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