Wednesday, June 7, 2017

Can I Trade my Old Bond for a New One when Interest Rate Goes Up?

Old Man Fishing in a boat in the river

Actual Question:

Should you sell your bond and buy a new one when interest rate increases?


Dear Friend

It is quite obvious that when interest rates increase, it is smart to sell the old bond with a lower coupon rate and buy a new one with a higher interest rate.

However, is it as simple as it appears?

Can one actually make such a smart move?

Well, the answer is NO and YES.

Financial markets worldwide are supposed to be efficient. Any such opportunities are quickly capitalised upon till the benefit exists no more.

How can this happen?

The market price of your old bond will fall immediately after the announcement the increase in the interest rate. The fall in the price usually will more or less match the potential gain.

However, ‘Value Investors’ also find that the markets are not as efficient as they are supposed to be. They always find a few stocks with excellent intrinsic values trading below their fair price. They also find that many good stocks as well as poor one trading at valuations that cannot be rationally justified. So you may indeed find an opportunity, though rare, to profit by selling the old bond and buying (subscribing) a higher interest rate denominated bond.

Thank you,

With Best Regards,