FINANCIAL FOCUS: IS IT TIME FOR A BOND SWAP?

This "Financial Focus" column is prepared by Edward Jones Investments, with headquarters in St. Louis and local branches in Cape Girardeau and Jackson.

If you own bonds, then you know they can provide you with a regular source of income and a way to diversify your portfolio. You also can improve your tax situation or gain other financial advantages through bonds, using a strategy called a "swap."

What does it mean to swap bonds? Basically, when you make a bond swap, you sell a bond and simultaneously purchase another bond with the proceeds from the sale.

Depending on the type of bond swap you make, you can accomplish any of several different objectives, including the following:

* Lower your taxes. Tax swapping is the most common of all swaps. Essentially, a tax swap allows you to use a capital loss -- incurred by a bond that has lost value -- to offset a capital gain you may have realized from selling an appreciated asset, such as a stock. If you have no capital gains, you can you use the capital loss to offset ordinary income.

In a traditional tax swap, you would sell a bond that is worth less than what you paid for it and then purchase a bond with similar, but not identical, characteristics. Your interest rate, maturity and quality of bond will be the same as before -- and you will have realized a loss that will save you money on taxes in the year of the bond sale.

Before making any tax swaps, consult your tax advisor. You may want to avoid buying a new bond within 30 days of selling one that is substantially identical. The IRS will not recognize tax losses from these so-called "wash sales."

* Increase your return. You may be able to improve the return of your bond portfolio by making a bond swap and extending the maturity of your bonds. That's because longer-maturing bonds generally pay a higher rate than short-term bonds. For example, you could sell a two-year bond with a 5.5 percent interest rate and purchase a 15-year bond that offers a 6 percent rate.

* Improve your portfolio's quality. When you make a quality swap, you move from a bond with a lower credit quality rating to one with a higher rating -- or vice versa. Independent rating agencies give bonds a "grade" ranging from AAA to C, or a similar scale. These grades reflect the agency's view of the bond issuer's ability to fully repay principal and make timely interest payments. Generally, the higher rated the bond, the lower the interest rate. The difference between the rates of bonds with different credit quality generally narrows during good economic times and widens when the economy weakens. So, if you expected the economy to slow significantly, you might swap from lower-quality to higher-quality bonds., with only a small loss in the rate you receive.

You may want to review your bond portfolio carefully with an investment expert. If you can identify areas in which you'd like to improve, the chances are pretty good that you can do it with a swap.

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.