Corporate Bond Market and Other Markets.

There are two types of markets: Primary and Secondary. When proceeds of sale of securities go directly to issuer, it is the Primary Market. The Secondary Market is the market where previously issued securities are traded. Proceeds from transactions in Secondary Market are not go to issuer, but to seller of the security.

Secondary Trades are occurred on Exchange Market or Over-the-Counter Market (OTC). The Exchange Market is a market where listed securities are bought and sold. Listed Security refers to any security that meet certain criteria before it will be allowed for trading on the exchange.

Exchanges, such NYSE, maintain trading floors, central market places and operate as an auction markets. Floor brokers compete to execute trades at the better price. Exchange Specialists maintain a fair and orderly market, and provide price continuity. They fill the limit and market orders for the public and trades for their own accounts to either stabilize or facilitate trading once imbalances in supply and demand occur. Some corporate bonds are traded on exchanges, however the OTC market is a major corporate bond market.

The OTC market is interdealer market with main function to provide marketplace for unlisted securities, which are not listed on any exchange. There are no central marketplaces in the OTC market. Computer networks and telephones in the OTC market connect securities dealers across the country. Registered Market Makers negotiate directly with each other to have the best executions price. The OTC market is negotiated market. Market Makers are brokers/dealers who are ready to buy or sell at least minimum trading unit. Market Makers, acting at a dealer capacity, buy for their inventories at the bid price, and sell from their inventory at their ask price.

Thousands of securities are traded on the OTC market, including stocks and government, municipal and most corporate bonds. The NasdaqOMX/eSpeed, TradeWeb, BondDesk and MarketAxess are the largest bond trading networks in US.

Brokers/Dealers

Brokers are agents that arrange trades for clients and charge commissions. Brokers do not buy securities for their inventories, but facilitate trades between sellers and buyers.

Dealers act as principals, buy and sell securities for their own accounts. Dealers charge the buying clients a markup, when selling them securities, and charge a markdown when buying securities from the selling clients.

Pricing

The current Bid is the highest price at which the dealer is ready to buy. The current Ask is the lowest price at which dealer is ready to sell. The difference between Bid price and Ask price is known as a price spread.

When dealer acts as a principal selling a Bond to a client from its inventory, the dealer marks up the Ask price to reach the final price to a client. When dealer buy a bond in a principal transaction, the dealer marks down from Bid price to reach the final price to a client.

Closing price is a final price at which a security is traded on a given trading day. The closing price represents the most up-to-date valuation of a security until trading commences again on the next trading day.

FINRA TRACE (Trade Reporting and Compliance Engine) was introduced in July 2002 in an effort to increase price transparency in the U.S. corporate bond market. The system captures and disseminates consolidated information on secondary market transactions in publicly traded TRACE-eligible securities (investment grade, high yield and convertible corporate bonds) – representing all over-the-counter market activity in these corporate bond market.

Different Bonds are quoted in different ways. Corporate and municipal bonds are quoted as a percentage of face value. Each bond price point represent $10, and the fractions are in eights (each 1/8=$1.25).
For example: a bond quoted at 100 ¾= $1007.50

Government Bonds are quoted as a percentage of face value. Each bond price point represent $10, and each 0.1 represents 1/32 (each 1/32=$0.3125).
For example: a bond quoted at 100.8= $1002.50

Features

Bonds, which have a Call option, refer as Callable Bonds. Callability is a feature that allows the issuer redeem its bonds (call its bonds) and pay off the principal before maturity on issuer’s discretion. Call Date is a date on which or after which the bond can be called in any time.

Generally, corporations use a Call Option for refunding its debt when interest rates are fallen. In these cases, corporations issue new bonds with a lower coupon and call back previously issued bonds with a higher coupon.

Convertible Bond has a Conversion option. Convertible feature permits issuer to convert bonds in to its common shares. Therefore, convertible bonds could be issued only by corporations. The conversion rate is set forth in the indenture at the time of a bond is issued. The conversion privilege is exercised at the discretion of the investor.

Generally, the indenture indicates the number of shares investor could get in exchange of one bond. If a conversion ratio is 20, it means that investor can get 20 common shares per one bonds. The face value of one bond is $1,000, thus a conversion price of one common share is $5. Sometimes, instead of conversion ratios, indenture will give a conversion price.

Investors have economic advantages to exchange Convertible Bond in to common shares only if market price of the share exceeds conversion price and investors have a bias that company’s stock will rise further in the future.

Usually corporations use a Convertible option when issuing debentures. Debentures are junior debt securities, which are issued without any collateral. Therefore, corporations use a convertible option to decrease the interest rate demanded by investors to purchase subordinated securities.

Many investors would like to purchase Convertible Bonds because the investor, as bondholder, is a creditor. If the company’s shares go down the investor simply receives regular interest payment and will be paid back at maturity. In case of company’s insolvent, bondholder’s claims are senior compare to shareholders claims. In the same time, if the company’s stocks soar, the investor can convert bonds in the company’s stock and participate in unlimited upside.