CAN YOU EXPLAIN THE BOND SWITCHING TECHNIQUE OF MOVING INTO LONG TERM - ProProfs Discuss
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Can you explain the bond switching technique of moving into long-term high-coupon bonds when interest rates are falling?



Asked by Birney, Last updated: Oct 20, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

When the bond price is rising, you want to select the most volatile bond characteristics. long-term coupon bonds are more volatile in price percentage change than short-term coupon bonds. low coupon bonds are more volatile in price percentage change than high coupon bonds. a long term low coupon bond would be the most volatile combination and would give you the greatest price gain in a falling interest rate environment.conversely, you would want to select the least volatile bond characteristics when prices are falling. the least volatile combination would be short-term high coupon bonds.now you know why, when interest rates are rising rapidly toward the end of the business cycle, investors are moving money out of stocks and into short-term bonds (preferably with high coupons). when interest rates peak and start to fall, investors start moving money from short-term bonds to long-term bonds to take advantage of rising prices. as interest rates fall far enough, the prospects for an improving business climate are anticipated and investors start moving money from long term bonds to stocks. as the economy expands and heats up and inflation becomes a threat, interest rates start rising again and the whole cycle of moving money from stocks to short term bonds begins again.
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