I am failing to understand the bond ETFs.
I somewhat understand stock ETFs: ETFs own stocks, I buy a part of ETF, therefore, I also indirectly own stocks. When I sell my share of ETF, the ETF gets the cash by selling the shares it owns. Is this the right thinking?
How does this work for bond ETFs? Bond ETF owns government bonds, which cannot be sold at any time? If it's a 20-year bond, can it be sold before? For what price?
How do the bond ETFs work?
Bonds can be bought and sold prior to maturity. If you download the holdings of an ETF from the manager's website, it will often include the prices of the bonds the fund holds.
The price depends on how interest rates have changed. All else equal, I would pay more for a treasury bond with a 5% coupon than for one with a 4% coupon. The prices of the two bonds will make the implied yield (or interest rate) roughly equivalent.
As an example, see the "Detailed Holdings and Analytics" link for TLT. The daily treasury curve is also a great resource if you're just starting to follow the bond market.
This is not a recommendation to buy or sell securities. It is provided for educational purposes only.
When I sell my share of ETF, the ETF gets the cash by selling the shares it owns. Is this the right thinking?
No. Selling your ETF shares is just like selling any other security. They are purchased by a buyer and cash is exchanged.
When an ETF company wants to create new shares of its fund, it uses an authorized participant (AP) who acquires the securities that the ETF wants to hold and then delivers those shares to the ETF provider. The provider gives the AP ETF shares in exchange and this is called a creation unit, generally in blocks of 50,000 shares. This also works in reverse as an AP removes ETF shares from the market.
The controlling party owns a wide range of short and long-term bonds. Both commercial and federal. They also likely own higher-risk bonds that pay a higher coupon rate. So like a stock ETF, you just purchase shares of the ETF and you own a portion of all those different bonds.
The bond ETF pays dividends, or modified coupon rates to you each month. So let's say the collective coupon rate is 5%, you may get 2%-3% of that and they keep 2% to reinvest for example. The ETF also will own some stocks to go along with the bonds in the portfolio. The links below show the holdings for the two bond ETFs I own.
NEAR pays 2% divided yield and SHV pays 1.4%.
Because of its diversification, it doesn't move a lot so you're mostly making money from your dividends each month.
There are also some fund fees that are paid to own the ETF. Somewhere around 0.15 %-0.25% range.
This is not investment advice.
