Basic Bond Pricing Question

[marko]

Wondering how bond prices are set.

In the simplest of terms as I understand it, stock prices are set when an individual/organization decides to buy a stock, the broker/market maker goes out and finds a seller willing to sell at the buyer's price.
The haggling in between is what sends the stock's price up or down.

How is that accomplished with bonds? Is it the same? Who/how makes those deals? And where? I don't see it happening in the pits on Wall St but it may; I keep hearing about 'bond auctions'.

I have no clue. (this is one reason why I stick to bond funds)

 

[COcheesehead]

There are bids and asks just like stocks, but volumes are lower so they go though dealers. Rates, duration, quality and other factors alter the pricing just like earnings and news will alter stocks.
Fidelity shows you all the buys and sells for bonds so you can see the deals in real time as well as the history, just like stocks.
There are also government auctions for new treasuries and you can buy new issue agency, corporates, munis, etc from dealers as well.

 

[VanWinkle]

There are bids and asks just like stocks, but volumes are lower so they go though dealers. Rates, duration, quality and other factors alter the pricing just like earnings and news will alter stocks.
Fidelity shows you all the buys and sells for bonds so you can see the deals in real time as well as the history, just like stocks.
There are also government auctions for new treasuries and you can buy new issue agency, corporates, munis, etc from dealers as well.

And there is a mark-up, spread, or commission for most corporate bonds that is hard to discern unless the dealer is willing to be open about all expenses.

Government treasuries from Treasury direct have no commissions or spreads.

 

[COcheesehead]

And there is a mark-up, spread, or commission for most corporate bonds that is hard to discern unless the dealer is willing to be open about all expenses.

Government treasuries from Treasury direct have no commissions or spreads.

Spread/mark up are visible/known at the time of purchase. Third party pricing is a guide. Commissions at Fidelity are $1/bond.
Spread works both ways. You can sell bonds and make money too.

 

[VanWinkle]

Spread/mark up are visible/known at the time of purchase. Third party pricing is a guide. Commissions at Fidelity are $1/bond.
Spread works both ways. You can sell bonds and make money too.

They are not disclosed when purchased by your advisor and can add up to the first years coupon when rates were minimal. Major brokerages like Fidelity are very up front about the commissions.

 

[COcheesehead]

They are not disclosed when purchased by your advisor and can add up to the first years coupon when rates were minimal. Major brokerages like Fidelity are very up front about the commissions.

I don’t use nor recommend an advisor just for reasons such as that. I learned my lessons long ago about paid advisors.

 

[pb4uski]

And there is a mark-up, spread, or commission for most corporate bonds that is hard to discern unless the dealer is willing to be open about all expenses.

Government treasuries from Treasury direct have no commissions or spreads.

They are not disclosed when purchased by your advisor and can add up to the first years coupon when rates were minimal. Major brokerages like Fidelity are very up front about the commissions.

You sort of switched gears there. For those of use who DIY, the spread and commission ($0 for me at Schwab) are perfectly visible from the broker and not hard to discern at all.

Then you shift to "purchased by your advisor"... IMO if you give your advisor trading authority then you deserve whatever you get.

 

[all4j]

A full answer to this would be quite lengthy & complicated. At a high level, one could say it works very much like stocks in that the price is set between a buyer & a seller. But for bonds, the process isn’t as standard to get there & that is one reason you’ll see mixed replies. You might start with a definition of some key terms – which I’ll touch on without trying to give a precise, concise definition. Let’s focus on corporate bonds on the secondary “market”. And by the way, vast majority of bonds are sold over the counter.

Individuals will go thru a “broker-dealer”; different broker-dealers handle things differently. Most will have an inventory of bonds they own that they are willing to sell. They will also act on your behalf to look at other broker-dealers. Kinda retail or wholesale function. Lookup term “markup” – comes into play when you are buying from their inventory. Not the same as bid/ask spread. Also not the same as commission. The distinction is often not clearly understood. (Also be careful with the term ‘spread’ as it may also be used to talk about a difference between a bond – or often a group of bonds -- & a benchmark).

I wouldn’t try to guess all the various ways broker-dealers provide info. Part of the challenge also comes up with very illiquid bonds. Not uncommon for a bond to go for days without being traded. Of course, everyday there are changes that MAY affect the ‘fair’ price of a bond. There is data available on executed trades so you can see when & at what price a bond sold for. But a lot may have changed since last trade.

So if you buy a corporate bond, you can likely know your ytm at time of purchase, but whether that is a good deal or not is up to you. It may also not be as good a deal as someone else at a different broker-dealer. And you may not know how much the broker-dealer profited. Buyer beware

 

[COcheesehead]

A full answer to this would be quite lengthy & complicated. At a high level, one could say it works very much like stocks in that the price is set between a buyer & a seller. But for bonds, the process isn’t as standard to get there & that is one reason you’ll see mixed replies. You might start with a definition of some key terms – which I’ll touch on without trying to give a precise, concise definition. Let’s focus on corporate bonds on the secondary “market”. And by the way, vast majority of bonds are sold over the counter.

Individuals will go thru a “broker-dealer”; different broker-dealers handle things differently. Most will have an inventory of bonds they own that they are willing to sell. They will also act on your behalf to look at other broker-dealers. Kinda retail or wholesale function. Lookup term “markup” – comes into play when you are buying from their inventory. Not the same as bid/ask spread. Also not the same as commission. The distinction is often not clearly understood. (Also be careful with the term ‘spread’ as it may also be used to talk about a difference between a bond – or often a group of bonds -- & a benchmark).

I wouldn’t try to guess all the various ways broker-dealers provide info. Part of the challenge also comes up with very illiquid bonds. Not uncommon for a bond to go for days without being traded. Of course, everyday there are changes that MAY affect the ‘fair’ price of a bond. There is data available on executed trades so you can see when & at what price a bond sold for. But a lot may have changed since last trade.

So if you buy a corporate bond, you can likely know your ytm at time of purchase, but whether that is a good deal or not is up to you. It may also not be as good a deal as someone else at a different broker-dealer. And you may not know how much the broker-dealer profited. Buyer beware

It is just that simple. Yield to worst YTW and yield to maturity YTM are known at the time of purchase and you can decide based on that. Too bad equities are not as simple.

 

[pb4uski]

Well if it helps, for all equities YTW is -100% and that is known at the time of purchase.

 

[COcheesehead]

Well if it helps, for all equities YTW is -100% and that is known at the time of purchase.

100% true.

 

[jazz4cash]

I had assumed that all new issue bonds would be issued at par. Now I realize that is not true and wonder how the issuer and underwriters settle on a coupon rate and I assume the market establishes discount/premium. I know a wee bit of how stock IPOs go through ‘price discovery’ but they don't have a coupon. It affects my choices for new issue muni bonds.

 

[DrRoy]

I had assumed that all new issue bonds would be issued at par. Now I realize that is not true and wonder how the issuer and underwriters settle on a coupon rate and I assume the market establishes discount/premium. I know a wee bit of how stock IPOs go through ‘price discovery’ but they don't have a coupon. It affects my choices for new issue muni bonds.

Zero coupon bonds pay no interest and issue at a discount. The return is paying par at maturity.

 

[COcheesehead]

Zero coupon bonds pay no interest and issue at a discount. The return is paying par at maturity.

Zeros pay imputed interest and if in a taxable account, you may owe taxes though you receive no actual income.

 

[all4j]

I had assumed that all new issue bonds would be issued at par. Now I realize that is not true and wonder how the issuer and underwriters settle on a coupon rate and I assume the market establishes discount/premium. I know a wee bit of how stock IPOs go through ‘price discovery’ but they don't have a coupon. It affects my choices for new issue muni bonds.

Zeros are not the only instance of bonds being issued at other than par. Also, there are some different rules for munis than corporates. In general I think the coupon rate is set more by art than science. Issuing entity wants to pay the least, but underwriter has to make sure it is high enough to sell. There are a variety of reasons why a bond may start out at other than par.

Add 2 more terms to understand. 1st, is "OID" or original issue discount. 2nd is for munis & is "de minimis" tax. Munis may have some tax after all!

 

[COcheesehead]

Zeros are not the only instance of bonds being issued at other than par. Also, there are some different rules for munis than corporates. In general I think the coupon rate is set more by art than science. Issuing entity wants to pay the least, but underwriter has to make sure it is high enough to sell. There are a variety of reasons why a bond may start out at other than par.

Add 2 more terms to understand. 1st, is "OID" or original issue discount. 2nd is for munis & is "de minimis" tax. Munis may have some tax after all!

Fidelity will issue a buy warning if you are tiptoeing into OID or de minimis land on a muni.

 

[jazz4cash]

Fidelity will issue a buy warning if you are tiptoeing into OID or de minimis land on a muni.

That's good to know. I was not referring to zeros when I posted my question. Most of my home state muni bonds are priced above par when issued. I figured the issuer wanted a relatively high coupon to attract buyers or the market moved from when the coupon was set so a price adjustment was necessary to match comparable bonds.