Friday, September 11, 2009

The secondary market for corporate bonds

The resale (secondary) market for corporate notes and bonds is relatively limited compared to the market for common stock, municipal bonds, and other long-term securities. Trading volume is thin, even for some bonds issued by the largest and best-known companies. Part of the reason is the small number of individuals active as investors in this market. Individuals generally have limited investment time horizons (holding periods) and tend to turn over their portfolios rapidly when attractive alternative investments appear. In the past secondary market trading in corporate bonds was also held back by the buy and holds strategy of major institutional investors, especially insurance companies and pension funds. Many of these firms purchased corporate bonds exclusively for their interest income and were content to purchase the longest-term issues and simply hold them to maturity. Today, however, under the pressure of volatile interest rates and inflation, many institutions buying bonds have shifted into a new aggressive strategy often labeled "total performance." Institutional portfolio managers are more sensitive today to changes in bond prices and look for near-term opportunities to trade bonds and score capital gains. In fact, a number of insurance companies, pension funds, and mutual bond funds operate their own trading desks and keep a constant tab on developments in the corporate debt markets.
Unlike the stock market, there is no one central exchange for bond trading which dominates the market. While corporate bonds are traded on all major securities‘exchanges, including the New York (NYSE) and American (AMEX) exchanges, most secondary market trading in bonds is conducted over the telephone trough brokers and dealers. Bond brokers act as middlemen by arranging trades between dealers in return for a small commission. Dealers, on the other hand, commit themselves to take on large blocks of bonds either from other dealers or from pension funds, insurance companies, and other clients. While bond dealers used to carry large inventories of securities in anticipation of customer orders most major dealer houses today have sharply reduced their inventory positions due to rapid and often unpredictable changes in interest rates. Many dealers now try to close out positions taken in individual bond issues in just a few days, frequently act only as middlemen in trades between major institutional investors without committing their own capital, and often hedge against the risk of large trading losses by using the financial futures markets.

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