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  • dattas Feb 1, 2013 9:12 PM Flag

    Can BOND avoid loss when interest rates rise?

    With a duration of 4 years (on the low end for an intermediate term bond) a 1% rise in interest rates will cause a loss in principal of 4%. That is bond math. This loss of principal is reflected in the NAV. At the current point where the 10 yr bond is at 2.01% an increase of .01% in the 10 yr rate reduces the PTTRX NAV (which BOND is supposed to emulate) by .01. Note that this is not a linear relationship.

    Some of these effects can be mitigated by purchasing floating rate bonds, buying TIPS (assuming the FED does not misreport true inflation), entering into floating for fixed swaps, currency swaps, puttable bonds and several other methods which we hopefully are paying Mr. Gross to think about.

    In April 2011 when 10 yr interest rates were 2.37% PTTRX was trading at 10.9 from the yahoo charts. To give a sense about the loss that would occur from a roughly .37% increase in interest rates you would lose (11.18 - 10.9)/11.18 = 2.5% of your holdings. Now you will receive some dividend in the interim so on the whole you won't lose everything.

    If the 10 yr interest rates rise to 4% instead of 2.37% in a short period of time from the current 2% you would lose about 8-10% of your money. I hope BOND and PTTRX are not comingled as the guys buying the ETFs appear to be retail investors who will be the first to stampede when they see this type of a drop.

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