Actual Question:
Should you sell
your bond and buy a new one when interest rate increases?
Answer:
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,
Anand
