Market volatility has created a discontinuity in the bond markets, and the widening gap is reflected in bond exchange traded funds (ETFs) through their their total return and discount to net asset values (NAV).

High-yield bond ETFs are among one of the most volatile bond funds that had large discounts to NAVs along with sudden price changes, remarks Kyle Waller for IndexUniverse. These funds saw most of their investors recede in a flight to quality.

Because of liquidity and fair-pricing issues in underlying bonds, bond ETFs usually trade at higher bands around their net asset values. There have also been some research done to see if bond ETFs can follow the price of their underyling bonds.

During the crazier periods of the credit crisis, the markets reflect the stale prices of the underlying holdings in the ETFs, despite low trading, which were at times lower than their NAVs, or price-setting for the individual bonds.

The discounts are a risk that show the potential manifestation of market prices that do not mirror the value in the underlying basket of securities in ETFs. The problem is whether or not high-yield ETFs will return to normal bands about their NAVs because they have yet to return to long-term averages. Of course, this could just be the consequences of a volatile market and any further risks to credit.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.