Buying and Trading

Buying and Trading Bonds

Newly issued bonds along with those being traded in the secondary market are available from stockbrokers and from some banks. Treasuries, though are sold at issue directly to investors without any intermediary or any commission. the Federal reserve Banks handle transactions in new treasury issues, bonds, bill, and notes. In-order to buy through the Federal Reserve, a investor needs to establish a treasury direct account that will keep records of the transactions, and it pay interest directly to the investor bank account. When the treasury issue is held to maturity, the par value is repaid directly as well.

Price is a factor that keeps individual investors from investing in bonds. While par value of a bond is usually around a $1000, bonds are often sold in bundles or packages that require a much larger minimum investment. High individual bond prices also limit the amount of diversification an investor can achieve. As a result, many people prefer bond funds, and many of the bonds themselves are bought by larger institutional investors.

Most already-issued bonds are traded over-the-counter. Bond dealers across the country are connected via electronic display terminals that give them the latest information on bond prices. A broker buying a bond uses a terminal to find out which dealer is currently offering the best price and then he calls that dealer to negotiate. Brokerages also have inventories of bond that they would like to sell to clients that are looking for bonds of particular maturities or yields. Sometimes investors make out better buying bonds their brokers already own.

While many newly issued bonds are sold without commission expense to the buyer, because the issuer absorbs the cost. The amount an investor pays to buy an older bond depends on the commission earned by the stockbroker involved, full service or discount, and the size of the markup that's added to the bond. markups are not officially regulated, and the total amount is not reported on confirmation orders, so charges can be excessive. However, investors that trade bonds to take advantage of fluctuating interest rates may find that their profits outweigh the costs of trading.

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Convertible Bonds

A convertible debt that can be converted into shares shares of common stock is known as a convertible corporate bond. The pricing or conversion ratio is based on a fixed convert price and the par value amount of bonds owned.
If an investor owns $1000 par value of a corporate bond that has a convertible price of 50 can own 20 shares of stock (1000 divided by 50). The pricing of these bonds tends to trade near par, since the price or interest rate risk with these bonds is less because of the conversion feature.

Normally when interest rates rise, bond prices go down. That is true with most bonds. Convertible securities offer investors a way out of the bond into stock of the company. That fact keeps the pricing market fairly stable on these bonds.

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Book Recommendation - Fixed Income Securities: Tools for Today's Markets, Second Edition, University Edition


Convertible bonds are bonds issued by corporations that are backed by the corporations' assets. In case of default, the bondholders have a legal claim on those assets. Convertible bonds are unique from other bonds or debt instruments because they give the holder of the bond the right, but not the obligation, to convert the bond into a predetermined number of shares of the issuing company. Therefore, the bonds combine the features of a bond with an "equity kicker" - if the stock price of the firm goes up the bondholder makes a lot of money (more than a traditional bondholder). If the stock price stays the same or declines, they receive interest payments and their principal payment, unlike the stock investor who lost money.

Why are convertible bonds worth considering? Convertible bonds have the potential for higher rates while providing investors with income on a regular basis. Consider the following:
1. Convertible bonds offer regular interest payments, like regular bonds.

2. Downturns in this investment category have not been as dramatic as in other investment categories.

3. If the bond's underlying stock does decline in value, the minimum value of your investment will be equal to the value of a high yield bond. In short, the downside risk is a lot less than investing in the common stock directly. However, investors who purchase after a significant price appreciation should realize that the bond is "trading-off-the-common" which means they are no longer valued like a bond but rather like a stock. Therefore, the price could fluctuate significantly. The value of the bond is derived from the value of the underlying stock, and thus a decline in the value of the stock will also cause the bond to decline in value until it hits a floor that is the value of a traditional bond without the conversion.

4. If the value of the underlying stock increases, bond investors can convert their bond holdings into stock and participate in the growth of the company.

During the past five years, convertible bonds have generated superior returns compared to more conservative bonds. Convertible bonds have generated higher returns because many companies have improved their financial performance and have their stocks appreciate in value.

Convertible bonds can play an important role in a well-diversified investment portfolio for both conservative and aggressive investors. Many mutual funds will invest a portion of their investments in convertible bonds, but no fund invests solely in convertible bonds. Investors who want to invest directly could consider a convertible bond from some of the largest companies in the world.

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Bond Broker Job

Selling Bonds

Type of Municipal Issues

There are two main types or ways a municipality can guarantee or back it's bond. One way is through the taxing power of the municipality. This would be called a General Obligation Bond or G.O. Bond. Another is called a Revenue Bond, which uses specific revenue sources to secure the issue.

General Obligation Bonds

These are the most common and normally the better rated issues. A state raising money and backing the bond issue with higher income or sales tax would be considered a G.O. Bond. A school district rasing money through a broker dealer on a municipal bond and securing the bond investors with school or property tax revenue is considered a General Obligation bond as well. Since taxes are the most secure source for money now and in the future, some investors prefer them over most revenue issues.

Revenue Bonds

Issues that rely on the revenue producing ability of a facility or from the issuer through other means are Revenue Bonds. There are several types of issuers. These would include:


Transportation - Bridges, Tolls, and Airports would be good examples
Health care - City or county hospitals
Utility Companies - Electric or water companies could assess usage increases to raise money.
Industrial - Some municipal issuers will work with private companies and use the company's lease payments to the city as a revenue source for bond issues.

Trading Treasuries - Trade for Treasury Ticks

The institutions that have strict policy guidelines on the bonds that they can buy are Banks, Credit Unions and Municipalities.

The spreads on Treasuries make them difficult to sell or “mark up” more than a few “ticks” to most sophisticated banks and institutions. A tick is 1 point in price. Government bonds are quoted in 32nds.

An example of a treasury bond would be: Bid 101-16 Ask: 101-24. If your client wanted to buy $10,000 of this treasury bond, you would see the price to you at 101-24 (24/32). 24/32 = .75. So the price is really 101.75 or $10,175. Each point represents $10 for every $1000 par bond. For $10,000, each point is worth $100. All bonds trade at a minimum of 1000. Institutions normally buy $250,000 up to tens of millions per trade. So, our example of a $10,000 trade really isn’t realistic and would not be worth your time. A “tick” by the way, is if the price went up to 101-25.

Trading for a few “ticks” on $100,000 would make you very little. If you factor in ticket charges, you might make $100 on the trade. You only present treasuries if it’s non competitive, or if the client is investing at least $1,000,000, otherwise it won’t make you much. If your client deals with 3 other brokers on treasuries, you will all be fighting for very little money. It’s very easy to get a quick quote on treasuries. Every major dealer owns them, and they can be purchased quickly. You or your trader will contact a major brokerage firm (Merrill Lynch, UBS etc.) and buy them. Not much money yes, still, it is assets you are controlling, and it could be used as available money to swap out of into a better investment for the client.

Treasuries are very safe of course, that’s why they are bought. Only buying treasuries will diminish the rate of return of the entire portfolio, if that is their only or main investment vehicle. Treasuries offer flexibility though. The market values on them will normally hold up well over time. They are very liquid and can be traded instantly. You should sell them only as “time bucket” or maturity gap placing.

If you see the bank has nothing maturing in the first half of a year for instance, you can recommend treasuries there too. Remember, institutions are looking for best price, but also good advice. The medium sized banks ($50 million - $500 million assets) will value good planning and thoughtful recommendations over dealing with 10 brokers all day. The larger institutions are more complicated, and require more price awareness. They think they have the ideas covered and you may have to just be an order taker with them.

Interest Earning Arbitrage - Bond Market Arb

People and investors who own bonds can profit from spread opportunities that present themselves in the credit and bond markets. This market best shows itself in corporate securities.

arbitrage opportunities in bond market

Arbitrage refers to buying an instrument or a commodity in one market and simultaneously selling it in another, making clear and risk less profit. Arbitrage opportunities are available when markets are not efficient. A person who makes risk less profit by using market inefficiencies is called an arbitrager.
Consider a 1 year maturity bond with face value of Rs100, coupon rate of 10%, paying coupon semi annually and bank interest rate is 5% pa.

Present value of the cash flows from this bond is

5/1.025 + 105/(1.025)2 = 104.82

If price of this bond is Rs100 in the market, one can borrow Rs100 from a bank and buy this bond. He will be able to pay Rs5 once he receives first coupon on this bond. By this time his outstanding amount will be 97.5 (100+100*2.5/100 - 5). At the end of one year he will receive Rs105 (principal + last coupon) which can be used to pay bank’s debt of Rs99.94 (97.5*1.025). He will make risk less profit of Rs 5.06

To exploit this situation every one tries to buy this bond by borrowing from banks to get risk less profit. As the demand for this bond increases the price also increases gradually to an extent that there won’t be any arbitrage opportunity. This happens in very less time in an efficient market giving less time for arbitragers to act.

The Handbook of Fixed Income Securities