Bond Trading

Bond trading can be done anywhere in the world where there is a buyer and a seller. Some corporate bonds are listed on exchanges but the majority of bonds are traded on an “over-the-counter” market, as there is no central exchange for bonds like there are for stocks.

This secondary market is created by bond dealers who connect buyers and sellers through a network of telephone and computer links, thereby providing liquidity for bond investors.

Bond dealers are typically represented by major investment dealers who house bond trading desks. These dealers have bond traders located at major financial centers who are knowledgeable about different groups of bonds and can quote the prices to buy or sell them.

Trading bonds is similar to stock trading. You can trade bonds through a full-service brokerage firm or an online trading account.

The prices of bonds are dictated by the market and are greatly impacted by interest rates. For example, when a bond is first issued, the initial price and interest rate are fixed. If a bond pays an interest rate of 6% and general interest rates increase to 7%, that bond will now be worth less because it is paying less interest than the going rate. Conversely, if interest rates drop to 5%, then the bond will be worth more, because it is paying 6% instead of 5%.

When a bond is trading for more than the initial price, it is trading at a premium which is commonly expressed as “over 100” which means that it is over 100% of the initial price. For example, let’s take a bond trading at a premium for a price of $104.17. To purchase $100 of that bond, it will cost $104.17. When the bond matures, you will receive the principal amount of $100.00 plus any outstanding interest.

The main risk associated with bonds is that the company issuing the bonds could go bankrupt. When this occurs, the bondholders get higher priority and are paid out prior to the shareholders. This does not guarantee a payout however, as no one gets paid if there is no money.

Generally speaking, the lower the risk, the lower the interest rate is on a bond. Very low risk bonds are rated AAA and high risk bonds are rated as CCC bonds and often referred to as “junk” bonds.

When you purchase a bond, you are loaning money to the company issuing the bond. Consequently you should evaluate the company’s ability to pay the interest on time and repay the loan by checking the company out, their earnings projections, level of debt, etc..

Bonds are less volatile in comparison to stocks. Due to their value being tied to the general interest rates, set maturity dates and coupon rates, one is able to calculate their worth in the future with much higher probability.

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