To The Moon

Hello everyone

Recently, news about the Federal Reserve cutting interest rates has been trending. Due to several key economic data points released by the U.S. on Tuesday falling short of expectations, there has been increased speculation and anticipation about further interest rate cuts by the Fed this year.

The market expects the Federal Reserve to cut rates twice in 2024, each by 25 basis points, while Fed officials predict only one cut.

Whether it's once or twice, the signal of rate cuts has caused the TLT fund, which invests in long-term Treasury bonds, to rise by 3.17% last week. Given the current situation, many investors are considering getting into TLT now. However, whether this is still a good entry point and how to proceed have become pressing questions for many.

Today, Tiger Academy will provide a brief analysis of the optimal approach!

1. How Much Upside Potential Does TLT Have?

Firstly, the signal for interest rate cuts is certainly a positive for TLT, but since TLT has already risen in response, we cannot be sure how much of the rate cut expectations are already priced in or whether we would be buying at a peak.

Secondly, the rate cut is currently just an expectation and not a certainty. Although the signal is relatively clear, most investors might reinforce this expectation under the overwhelming views and information from institutions, thereby overlooking the risks.

Finally, assuming the rate cuts do materialize in the future, how much increase can TLT experience? Let's do a rough calculation. Assuming the mainstream view of two rate cuts totaling around 0.5% in 2024.

Based on the modified duration range of the top ten Treasury bonds held by TLT, a rough estimate puts the entire portfolio's duration between 10 and 15. This means that even if the positive impact materializes, TLT’s theoretical increase should be around 5% to 7.5%. Moreover, this calculation does not account for the recent gains already priced in due to the rate cut signal.

Of course, in addition to capital gains, investors can also earn coupon income from the bonds held by the fund. However, this coupon income is relatively low and only provides a modest boost to the overall return.

Therefore, Tiger academy concludes that if you want to benefit from the positive effects of interest rate cuts but are concerned about the limited returns and potential risks of buying TLT at its current high, there is a highly cost-effective product with returns potentially doubling those of TLT. This product is the FCN (Fixed Coupon Note) linked to TLT. Let's demonstrate how investing in the FCN product compares in terms of risk and return.

2. Risks and Returns of TLT's FCN Product

If we are optimistic about TLT's future performance but are concerned about getting caught at a high price, we can consider buying an FCN (Fixed Coupon Note) product linked to TLT. Let's look at the specific parameters for setting this up.

Assuming we think a reasonable target entry price is 98% of the current price, we can set the strike price ratio at 98%. This means that if TLT drops by 2%, we can buy in at a lower price. With a knockout price ratio set at 110% (triggered if TLT's price increases by more than 10% on the observation date), we have secured an optimal quote ratio of up to 9.04%.

Here’s a summary of the parameters and their implications:

• Strike Price Ratio: 98% (TLT needs to drop by 2% for this to trigger, allowing for a lower entry price)

• Knockout Price Ratio: 110% (if TLT rises by more than 10%, the note will be knocked out)

• Optimal Quote Ratio: 9.04% (potential return based on these conditions)

This setup allows investors to benefit from potential declines to buy TLT at a lower price while also securing a substantial return if the price conditions are met.

Returns

The 9.04% yield of the FCN product is significantly higher than the previously estimated 5%-7.5% return from directly buying TLT. If we exclude the 3% gain TLT experienced last week due to news impact, the FCN product's yield is already double the estimated return of directly buying TLT. This alternative approach effectively doubles the potential return!

Moreover, the coupon yield of the FCN product is relatively fixed, providing more certainty compared to the fluctuating returns of stocks.

Risks

The primary risk of the FCN product is if TLT's price drops significantly more than 2% below the strike price. While this would still allow us to buy TLT at our target price, further declines would result in losses. However, it’s important to note that buying TLT through the FCN product, even in such a scenario, still provides a 2% safety margin compared to buying TLT at its current high price.

For those concerned about the risk of buying TLT at a lower strike price, you can consider further lowering the strike price ratio. While this might reduce the yield slightly, the cost-effectiveness of the FCN product would still be much higher than directly purchasing TLT.