bond swap

Bond Swap

A strategy in which an investor sells a bond and at the same time purchases a different bond with the proceeds from the sale.

Notes:

There are several reasons why people use a bond swap: to seek tax benefits, to change investment objectives, to upgrade a portfolio's credit quality or to speculate on the performance of a particular bond.

See also: Bond, Discount Bond, Face Value, Premium Bond, Swap, Wash Sale

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Bond swap

The sale of one bond issue and purchase of another bond issue simultaneously. See: Swap; swap order.

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bond swap

The selling of one bond issue and concurrently buying another issue in order to take advantage of differences in interest rates, maturity, risk, marketability, and other factors. In some instances, especially with municipals, bond swaps are undertaken in order to realize losses for tax purposes. See also intermarket spread swap, rate anticipation swap, reverse swap, substitution bond swap, tax swap.

How can I obtain a tax benefit from a bond swap?

Bond swaps are done for many reasons (such as to improve income, improve quality, change maturity schedule, or enhance diversification). Thus, if the bond swap is worthwhile, it will be done for various economic reasons rather than simply for tax benefits. (Of course, there is nothing wrong with obtaining a tax benefit at the same time.) A tax benefit is often realized when an investor sells bonds that were acquired during a period when interest rates were lower than they were at the time of the swap. Because interest rates rose, bond prices fell, and the seller is able to generate a tax-deductible capital loss. The tax savings may be viewed as an ancillary benefit derived from the bond swap. A word of caution is in order, though: if you are considering a bond swap that will generate a tax-deductible capital loss, do not swap into a security classified by the Internal Revenue Service as basically identical to the one you sold until the appropriate time period has passed. Otherwise, the loss will be disallowed for tax purposes.

Stephanie G. Bigwood, CFP, ChFC, CSA, Assistant Vice President, Lombard Securities, Incorporated, Baltimore, MD