Investment Strategies - Swap and Collar Strategies

The main purpose behind bond swaps is to increase return.

    1. Substitution swap - The exchange of bonds with identical features (creditworthiness, maturity, coupon, YTM, call features) at different prices in order to exploit pricing inefficiencies. Risks include the fact that the bonds exchanged may not be perfect substitutes, gains may be realized that do not cover the costs of the transaction and the time necessary for the bonds' prices to equal one another (the workout time) may take longer and result in lower returns than required.
    2. Intermarket spread swap - The exchange of similar bonds with different coupons. The idea is that a change in yield could result in a price change that benefits the investor. The purchase of a bond with the higher yield could be less expensive and the sale of the lower yielding bond could generate income resulting in a net gain to the investor. However, yield changes may not rebound to the investor's benefit and the swap could result in a capital loss.
    3. Rate Anticipation swap - This exchange occurs in anticipation of an increase or decrease in interest rates. A rate rise would warrant a swap out of a long-term bond, which would be expected to decline in price, for a shorter-term bond which is less price sensitive due to its shorter duration. Conversely, a rate decline could warrant the sale of a short duration credit for the purchase of a longer term bond to benefit from a price increase.
    4. Pure yield pickup swap - This entails the exchange of a bond with a lower yield to maturity for one with a higher yield to maturity. The newer bond would have to be of a longer maturity or lower quality, making it less expensive relative to the bond sold resulting in a net gain to the investor.
    5. Tax Swap - Such a strategy is designed to benefit from current tax law. For example, an investor could sell a bond at a loss and repurchase the bond for the lesser amount, using the tax savings from the loss to reinvest. Investors need to avoid running afoul of the wash sale rules. With bonds, one may avoid purchasing a substantially identical security by purchasing a bond with similar characteristics from a different issuer.
Formula Investing Strategies
Related Articles
  1. Personal Finance

    How the Social Security Reboot May Affect You

    While there’s still potential for some “tweaking” around your Social Security retirement benefits, I’d like to share some insight on what we know now.
  2. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  3. Entrepreneurship

    Creating a Risk Management Plan for Your Small Business

    Learn how a complete risk management plan can minimize or eliminate your financial exposure through insurance and prevention solutions.
  4. Investing Basics

    5 Tips For Diversifying Your Portfolio

    A diversified portfolio will protect you in a tough market. Get some solid tips here!
  5. Entrepreneurship

    Identifying And Managing Business Risks

    There are a lot of risks associated with running a business, but there are an equal number of ways to prepare for and manage them.
  6. Active Trading

    10 Steps To Building A Winning Trading Plan

    It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself.
  7. Trading Strategies

    How to Trade In a Flat Market

    Reduce position size by 50% to 75% in a flat market.
  8. Credit & Loans

    Unsecured Personal Loans: 8 Sneaky Traps

    If you are seeking a personal loan, be aware of these pitfalls before you proceed.
  9. Chart Advisor

    Is This The Beginning Of A Downtrend In Home Builders?

    Falling lumber prices and weakness on the charts of home builders suggest that the next leg of the trend could be downward.
  10. Professionals

    'Man Up': 3 Tips for Working with Male Clients

    Male clients aren't always financially literate. Here's how advisors can meet their needs.
  1. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  2. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  3. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  4. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  5. Gross Exposure

    The absolute level of a fund's investments.
  6. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  1. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  2. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  3. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  4. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
  5. Do financial advisors work only in banks?

    While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>
  6. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  3. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  4. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  5. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  6. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
Trading Center