Hedging Against Falling Tin Prices using Tin Futures

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  • TERM Spring ’17
  • PROFESSOR APTE
  • TAGS Management,Interest,Interest Rate, USD, Hong Kong Futures Exchange, Futures Commission
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Using ETFs To Hedge Against Rising Rates

September 29, 2020

The September Federal Reserve meeting passed without much fanfare, quieting markets that had been getting jittery about a rate hike. The central bank―eyeing the uncertainty of a presidential election in November―chose to delay its much-anticipated interest rate increase, but not for long.

After the no-change decision, Federal Reserve Board Chair Janet Yellen told the press that she expects a rate hike sometime this year. That means that an increase may come either at the November or December meeting, with most economists targeting the latter as the likeliest option for a move.

If so, it will be deja vu, for it was last December when the Fed hiked rates for the first time in nearly a decade after months of anticipation. Another hike this December would push the federal funds rate up by 25 basis points to a range of 0.50-0.75% from 0.25-0.50%.

Rates Down From Start Of Year

Market-set rates are up from their lows ahead of the potential rate increase, though they’re down significantly from where they were at the start of the year.

The two-year Treasury bond yield, for example, is at 0.75%, up from a low of 0.50% in June, but down from 1.05% on Dec. 31. At the same time, the 10-year Treasury bond yield is at 1.56%, up from a record-low 1.32% in July, but down from 2.27% on Dec. 31.

It’s impossible to say whether the next Fed hike will be the catalyst that finally spurs a big rally in interest rates (and sell-off in bonds). But for investors who want to protect themselves, there are many tools available in the ETF world to minimize the impact of higher rates, or even capitalize on them.

Lower Duration Bonds

The classic advice given to investors in a rising rate environment is to reduce the duration of your bond portfolio. Duration is a measure of interest rate risk and is based on a bond’s maturity and coupon payments.

A higher-duration portfolio has more interest rate risk than a lower-duration portfolio. By reducing duration―for example, by buying shorter-term bonds―a portfolio will have less interest rate risk. The flip side is that the portfolio will probably have a smaller yield as well.

There are plenty of low-duration ETFs on the market that can help reduce the average duration of an investor’s portfolio, including the iShares 1-3 Year Treasury Bond ETF (SHY), the PIMCO Enhanced Short Maturity Active ETF (MINT) and many more.

Inverse Bond ETFs

Another method with which to hedge against rising rates is inverse ETFs. These funds short Treasury bonds, meaning they rise in price when interest rates increase (bond prices and rates generally move inversely).

The ProShares Short 20+ Year Treasury ETF (TBF) provides daily inverse exposure to Treasurys with maturities greater than 20 years.

Meanwhile, the Sit Rising Rate ETF (RISE) shorts futures contracts on two-, five- and 10-year Treasurys with a specific goal of maintaining a duration of negative 10. That means if interest rate rise by 1%, the ETF should rise by 10% (and vice versa).

TBF, RISE and similar ETFs can be used to hedge other bond funds in a portfolio or as stand-alone products to speculate on the direction of interest rates.

Keep in mind, however, that any product that shorts positive-yielding bonds will have to pay a cost to maintain that position over time. This can result in losses even if interest rates remain flat.

YTD Returns For TBF, RISE, TLT, IEF

Long/Short Bond Funds

Another group of ETFs attempts to reduce duration by simultaneously holding long and short positions in bonds. The WisdomTree Barclays US Aggregate Bond Negative Duration Fund (AGND) holds the bonds in the Barclays Aggregate Bond Index and a short position in Treasurys at the same time. The result is a portfolio of bonds with a duration of negative 5.

Once again, AGND could be used as a stand-alone product to speculate on interest rates or combined with, say, another position in the iShares Core U.S. Aggregate Bond ETF (AGG) (which incidentally has a duration of positive 5) to reduce an investor’s interest rate risk.

ETFs that use a similar strategy as AGND’s include the VanEck Vectors Treasury-Hedged High Yield Bond ETF (THHY) and the ProShares High Yield-Interest Rate Hedged ETF (HYHG), which short Treasurys to hedge a portfolio of high-yield bonds. Both target a duration of zero.

YTD Returns For AGND, THHY, HYHG, AGG, HYG

Floaters

For investors who want to do away completely with interest rate risk, a straightforward solution floating-rate ETFs. The iShares Floating Rate Bond ETF (FLOT) holds a basket of bonds with maturities of five years or less. As floating rate notes, the interest rates on these securities resets periodically based on market rates; so if rates increase, the payout increases too (the downside is that rates on floaters will tend to be lower to account for the smaller risk).

Floaters are attractive compared to fixed-rate bonds when rates are expected to increase, but not as attractive when rates are expected to decline.

The PowerShares Senior Loan Portfolio (BKLN) is another type of floating-rate ETF. It tracks an index of the 100 largest bank loans with floating rate coupons. The fund has little interest rate risk, but relatively high credit risk due to its below-investment-grade portfolio.

YTD Returns For FLOT, BKLN, SLQD, HYG

How to Hedge Against Further Falling Oil prices

Crude oil prices and oil-related ETFs have surged this year, but the energy market may be entering a period of seasonal weakness.

Year-to-date, the United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate crude oil futures, advanced 18.3% and the United States Brent Oil Fund (NYSEArca: BNO), which tracks Brent crude oil futures, increased 19.5%.

WTI crude oil futures are now trading around $69.8 per barrel and Brent crude futures hovering around $79.4 per barrel.

The supply disruptions experienced earlier in the year have helped push up prices, but crude oil has since started trading within range. However, analysts warned of falling demand as we shift over to a seasonally weak period for the energy market.

Finance English practice: Unit 34 — Futures

  • Complete the sentences below. Use the key words if necessary.
    • Commodity futures

    are agreements to sell an asset at a fixed price on a fixed date in the future. are traded on a wide range of agricultural products (including wheat, maize, soybeans, pork, beef, sugar, tea, coffee, cocoa and orange juice), industrial metals (aluminium, copper, lead, nickel and zinc), precious metals (gold, silver, platinum and palladium) and oil. These products are known as .

    Futures were invented to enable regular buyers and sellers of commodities to protect themselves against losses or to against future changes in the price. If they both agree to hedge, the seller (e.g. an orange grower) is protected from a fall in price and the buyer (e.g. an orange juiced manufacturer) is protected from a rise in price.

    Futures are contracts — contracts which are for fixed quantities (such as one ton of copper or 100 ounces of gold) and fixed time periods (normally three, six or nine months) — that are traded on a special exchange.

    Forwards are individual, contracts between two parties, traded — directly, between, two companies of financial institutions, rather than through an exchange. The futures price for a commodity is normally higher than its — the price that would be paid for immediate delivery. Sometimes, however, short-term demand pushes the spot price above the future price. This is called .

    Futures and forwards are also used by speculators — people who hope to profit from price changes.

    More recently, have been developed. These are standardized contracts, traded on exchanges, to buy and sell financial assets. Financial assets such as currencies, interest rates, stocks and stock market indexes — continuously vary — so financial futures are used to fix a value for a specified future date (e.g. sell euros for dollars at a rate of €1 for $1.20 on June 30).

    and are contracts that specify the price at which a certain currency will be bought or sold on a specified date.

    are agreements between banks and investors and companies to issue fixed income securities (bonds, certificates of deposit, money market deposits, etc.) at a future date.

    fix a price for a stock and fix a value for an index (e.g. the Dow Jones or the FTSE) on a certain date. They are alternatives to buying the stocks or shares themselves.

    Like futures for physical commodities, financial futures can be used both to hedge and to speculate. Obviously the buyer and seller of a financial future have different opinions about what will happen to exchange rates, interest rates and stock prices. They are both taking an unlimited risk, because there could be huge changes in rates and prices during the period of the contract. Futures trading is a , because the amount of money gained by one party will be the same as the sum lost by the other.

  • British English or American English?
    • aliminium
      • British English
      • American English

    • aluminum
      • American English
      • British English

  • Match the definitions with the words below.
    • 1. the price for the immediate purchase and delivery of a commodity — . . .

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