A Bond Swap is simply the sale of one bond and the purchase of another, designed to better meet your investment objectives or to take advantage of current market or tax conditions. Some of the more common bond swaps include the following: rate anticipation swap, substitution swap, intermarket swap, and tax swap.

• A rate anticipation swap is made to take advantage of changes in market interest rates. It typically involves swapping short- for long-term bonds or vice versa, depending on your beliefs about the future direction of interest rates. If you anticipate interest rates will increase, you might swap out of longer-term bonds into shorter-term bonds. Then, when interest rates increase, your bonds won't be significantly affected by the rate change, and you will have funds available to invest at higher rates. If you anticipate lower interest rates, you would do the opposite to lock in current rates.

• A substitution swap involves swapping one bond for another similar bond with higher yields. That could happen if a company's financial situation has improved, but the bond's credit rating hasn't been upgraded yet.

• An intermarket swap involves swapping bonds in different market sectors, such as government and corporate, to take advantage of changing yield spreads. For instance, the spread between corporate and municipal bonds may narrow, making the returns on municipal bonds higher than corporate bonds on a tax-equivalent basis.

• A tax swap is made to realize a bond's loss for tax purposes. You sell bonds with a current market value less than your purchase price so you can realize the loss and deduct it on your tax return. You then use the proceeds to purchase a similar bond. The end result is you own a comparable bond, but you also have a tax loss to deduct on your tax return. That loss can be used to offset other capital gains or to offset up to $3,000 of ordinary income in excess of gains, with any excess losses carried forward to future years.

When making a tax swap, you must comply with the Wash Sale rules. A Wash Sale occurs when an investor sells a security at a loss and 30 days before or after the sale purchases a substantially identical security. If deemed a wash sale, the loss can be deducted for tax purposes. If you want to purchase another bond within the 30-day window, the new bonds must differ in a material way from the bond sold, such as different issuers, coupon rates, or maturity dates.