How do they work with bonds and do they depend on the types?
Basically, a bond swap is an exchange of two or more bonds issues. Effectively, you are changing one cash flow for another. A simple type of swap (or hopefully, portfolio improvement) involves the sale of an overvalued issue for one that is fairly or even undervalued. In a broad sense, when yield spreads between quality grades are narrow, portfolio managers would look to upgrade since the higher quality issues are relatively more attractive than the lower quality ones. When spreads are wide then look to downgrade. Note that not all bond swaps are portfolio improvements. Sometimes they may only benefit the bond salesman and his firm. Other types of swaps may involve going from long bonds to shorter issues and vice versa, quality improvements, anticipation of downgrades or upgrades, etc. In the municipal market one often hears of tax swapping towards year end. This involves the sale of a bond in which you have a loss and the purchase of another with similar or better characteristics. The
