A Bond Swap can be described as the act of an investor using the revenue from the sale of one bond to purchase another bond for a similar price. A bond itself is an investment of debt where the investor loans funds to a government or corporation at a fixed interest rate over a specific period of time. Interest on bonds can be paid every six months (semi-annually) or every year (annually). The different types of bonds include U.S. Treasury bonds, municipal bonds and corporate bonds. Bond maturity rates can vary greatly for a Treasury bond – from 90 days to 30 years, while a municipal or corporate bond will typically last between 3 to 10 years.
A Bond Swap occurs when an investor chooses to sell one bond and immediately purchase another bond with the proceeds from this investment. One reason an investor may choose to do this is if they anticipate a change in interest rates, so they can benefit from a higher interest rate or protect against a potential drop in rates. Another reason an investor may choose to do this is to increase their yield by swapping a short-term bond for a long-term bond, thus extending the maturity of the investment. Many investors will also choose to execute a Bond Swap for tax purposes, the investor can write off losses on a bond, sold to lower tax liability, and then earn a better rate of return on their new investment.