Corporate Bonds: Check Out These Curves!

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1 Corporate Bonds: Check Out These Curves! It s widely believed that the U.S. economy is the bus driver and we are all along for the ride when it comes to determining the future of interest rates. The U.S. Federal Reserve has supported keeping short-term interest rates low through at least late 2014 according to the January 25, 2012 Bloomberg article Fed: Benchmark Rate Will Stay Low Until 14. The current Federal Funds Rate is 0.12% as of February 14, 2012, for an approximate annualized yield of 0.48%. Let s not argue with the bus driver on the front end of the yield curve and let s focus on the back of the bus instead. Is it time to get more exposure to spreads while shortening duration? To answer this question, we must first look at long-term interest rate expectations and growth expectations for the U.S. economy. PIMCO s Marc Seidner purports that the U.S. Federal Reserve s Operation Twist was destructive to Treasury investors in his article The Three R s of Investing: Operation Twist [which began in October 2011 and ends in June 2012], [is] the Fed s subsequent plan to adjust its balance sheet by selling Treasury notes with maturities less than three years and buying T-notes and T-bonds longer than six years, is repressive to all Treasury investors. Operation Twist is essentially increasing the yields on short-term Treasuries and decreasing the yields on longer term Treasuries.

2 30-Year U.S. Treasury Yield Curve: February 16, 2011 to February 16, 2012 Source: Bloomberg, between February 16, 2011 and February 16, Corporate earnings are often thought of as a good indicator of economic performance. Corporate bond spreads would generally be expected to tighten in periods of lower expected unemployment and rising corporate earnings because there is less risk of corporations defaulting on their loan payments with the higher earnings.

3 Quarterly S&P 500 Index Constituent Earnings Per Share: December 31, 2009 to December 31, 2011 (Estimated) $30.00 Quarterly S&P 500 Index Constituent EPS: December 31, 2009 to December 31, 2013 (Estimated) $25.00 Earnings Per Share ($) $20.00 $15.00 $10.00 $5.00 $0.00 Q Q Q Q Q Q Q Q *Q ** Q ** Q ** Q ** Q ** Q ** Q ** Q ** Q Quarter End Reported EPS For S&P 500 Index Constituents 2 Year EPS Moving Average Source: Standard and Poors, as of February 16, * Q4 2011: 81% of firms reported Q4 EPS as of February 16, ** Estimated quarterly EPS. The U.S. unemployment rate can also be considered as confirming evidence for the strength in U.S. corporate earnings. The U.S. unemployment rate has been on a decreasing trend over the last two years, period ending January 31, 2012.

4 U.S. Unemployment Rate, Seasonally Adjusted: January 2010 to January 2012 Source: U.S. Department of Labor, Bureau of Labor Statistics, February 16, Despite higher earnings expectations and lower unemployment, Canadian and U.S. corporate bond spreads have been reported, generally, as being between 125 to 300 basis points (bps) from January 2010 to January 2012.

5 Canadian IG Corporate Bond Yields and Spreads: 1989 to 2012 Source: Natcan Investment Management Inc., as of February 14, U.S. IG Corporate Bond Yields and Spreads: 1989 to 2012 Source: Natcan Investment Management Inc., as of February 14, 2012.

6 If you believe long-term interest rates will rise but corporate bond spreads will narrow: HTD (2x): 200% leveraged inverse exposure to the U.S. 30-Year bond HUF.U (1x): Exposure to short-term U.S. corporate bond yields while maintaining a portfolio duration of less than two years, denominated in U.S. dollars. HFR (1x): Exposure to a portfolio of Canadian and U.S. debt securities with a portfolio duration of less than two years, denominated in Canadian dollars. If you believe long-term interest rates will decrease but corporate bond spreads will remain the same: HTU (2x): 200% leveraged exposure to the U.S. 30-Year bond The views expressed herein are of a general nature and this Trade Idea is not and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors. ETF Performance as of January 31, 2012 ETF 1 mo 3 mo 6 mo YTD (2012) 1 yr 3 yr Since Inception Inception Date Annual Management Fee HUF.U February 15, % HFR December 10, % HTU June 25, % HTD June 25, % 1 This ETF does not seek to meet its investment objective over any period other than daily. 2 The performance of HUF.U cannot be displayed for any period since the inception date of the fund is less than one year. Wade Guenther, CFA ETF Research Analyst Horizons Exchange Traded Funds HUF.U Investment Objective The investment objective of Horizons U.S. Floating Rate Bond ETF ( HUF.U ) is to generate income that is consistent with prevailing U.S. short-term corporate bond yields while stabilizing the market value of HUF.U from the effects of U.S. interest rate fluctuations. HUF.U invests primarily in a portfolio of U.S. corporate debt securities and will hedge the portfolio s U.S. interest rate risk to generally maintain a portfolio duration of less than two years. HUF.U may also invest in U.S government debt securities and debt securities of non-u.s. companies. HUF.U may also invest in debt securities directly, or through investments in securities of other investment funds, including exchange traded funds. HUF.U will use derivatives, including interest rate swaps, to deliver a floating rate of income. As HUF.U is denominated in U.S.

7 dollars, HUF.U will generally seek to hedge its Canadian dollar currency exposure to the U.S. dollar and will not seek to hedge its U.S. dollar currency exposure to the Canadian dollar. HFR Investment Objective The investment objective of the Horizons Floating Rate Bond ETF ( HFR ) is to generate income that is consistent with prevailing short-term corporate bond yields while stabilizing the market value of HFR from the effects of interest rate fluctuations. HFR invests primarily in a portfolio of Canadian debt securities and hedges the portfolio's interest rate risk to generally maintain a portfolio duration of less than two years. HFR may also invest in debt securities of U.S. companies, directly, or through investments in securities of other investment funds, including exchange traded funds. HFR may use derivatives, including interest rate swaps, to deliver a floating rate of income. HFR, to the best of its ability, seeks to hedge its non-canadian dollar currency exposure to the Canadian dollar at all times. HTU and HTD Investment Objectives The Horizons BetaPro U.S. 30-Year Bond Bull Plus ETF ( HTU ) and the Horizons BetaPro U.S. 30-Year Bond Bear Plus ETF ( HTD ) seek daily investment results equal to 200% the daily performance, or inverse daily performance, of the U.S. 30- Year Bond futures contract for the next delivery month. HTU and HTD are denominated in Canadian dollars, as the U.S. dollar exposure of the underlying index is hedged daily. The views expressed herein may not necessarily be the views of AlphaPro Management Inc., Horizons ETFs Management (Canada) Inc. or Horizons Exchange Traded Funds Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors. Commissions, trailing commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by AlphaPro Management Inc. and Horizons ETFs Management (Canada) Inc. (the Horizons Exchange Traded Products ). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. Please read the prospectus before investing. The Horizons Exchange Traded Products include the Horizons Bull Plus and Bear Plus ETFs ( Plus ETFs ) and active ETFs. The Plus ETFs, and certain other Horizons Exchange Traded Products, use leveraged investment techniques that magnify gains and losses and result in greater volatility in value. These Horizons Exchange Traded Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, which, where applicable, are described in their respective prospectuses. Each Plus ETF seeks a return, before fees and expenses, that is either 200% or -200% of the performance of a specified underlying index, commodity or benchmark (the Target ) for a single day. The indicated rates of return for the Horizons Exchange Traded Products in the performance tables are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends and distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any

8 unitholder that would have reduced returns. Due to the compounding of daily returns, a Plus ETF s returns over periods other than one day will likely differ in amount and possibly direction from the performance of their respective Target(s) for the same period. Investors should monitor their holdings, as frequently as daily, to ensure that they remain consistent with their investment strategies. All trademarks/service marks are registered by their respective owners. None of the owners thereof or any of their affiliates sponsor, endorse, sell, promote or make any representation regarding the advisability of investing in the Horizons Exchange Traded Products. Complete trademark and service-mark information is available at