The Workout Time

In many of the swap situations described herewith, the investor is counting on a realignment of values to take place over a period of time. We shall refer to this period as the "workout time." For example, in the Substitution Swap, the investor knows that the H-bond (the bond now held) and the P-bond (the proposed purchase) will certainly coincide in price at maturity. This then is the longest possible "workout time" for the Substitution Swap. If the two bonds are indeed perfect substitutes in the marketplace, aside from the momentary aberration which provided the swap opportunity, then the workout time should be fairly short, perhaps a few months. The sooner the swap works out, i.e., the sooner the momentarily underpriced P-bond recovers its anticipated equality with the H-bond price, the quicker the investor can if he wishes pick up his anticipated capital gain. This in turn serves to improve his rate of return over the workout period of the swap.

It should be emphasized, however, that to realize the full advantage from such swaps there is no need at all of actually reversing them. Provided only that the discount on the P-bond, which caused its purchase, has been eliminated, the investor can retain the full advantage of his gain by simply holding the P-bond or by swapping it at the end of the workout period into a third issue which is then underpriced.

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