Once the bond is issued in the primary market, they start getting traded in the secondary market. The value of the bond which was bought at its face value now starts trading at a discount or premium depending on the demand and market conditions. Bonds can be traded in various ways, on-market or off-market methods.
Although many bond investors employ a “buy and hold” strategy, there are circumstances when they may wish or be forced to sell bonds before maturity. The secondary bond market is the marketplace where investors can buy and sell bonds. A key difference compared to the primary market is that proceeds from the sale of bonds go to the counter-party, which could be an investor or a dealer, whereas in the primary market, money from investors goes directly to the issuer.
Par Value vs. Market Value
Bonds have a par value and market value. If an investor holds a bond to maturity, the principal amount repaid by the issuer, provided the issuer does not default, is the par value. However, when an investor sells a bond prior to maturity, the proceeds received reflect the bond’s market value. The market value is the price a counter-party is willing to sell or buy a bond for in the secondary market. The market value can be significantly different from par value based on a number of factors such as interest rate risk, liquidity risk, call risk etc.
Since bonds are generally traded over-the-counter (OTC) by dealers or via online platforms, transaction costs are not standardized like they are for equities traded on an exchange. Instead of upfront commissions (Ex- Rs 20 per trade), like for equities, bond transaction costs are included into the dealer’s spread. These transaction costs can be referred to as “markdown” or “markup”. A markdown or markup is the cost in excess of the “market” offer that the buyer is charged by the dealer. For example, markdown would be a reduction of the bond sale price from its current market bid price, where the current market bid price is the price the dealer could immediately resell the bond to another dealer. The markdown or markup varies based on different types of bonds and different dealers. As markdowns and markups are embedded in the bid-offer spread, it can often be difficult for investors to accurately determine transaction costs.
Shrinking Secondary Market Liquidity
Most transactions in the secondary bond market are facilitated by dealers. Historically, dealers held large inventories of corporate bonds on their balance sheets, which allowed them to provide liquidity support for the secondary market.
What are on-market transactions?
Buying and selling of bonds through BSE/NSE are called on-market trades. This can be done in 2 ways:
Over the counter(OTC)- This is a pre-arranged deal via a broker-dealer network. It could be done for both listed and unlisted bonds. These deals are usually settled through ICCL & NSCCL
Exchange traded market- This is a real time trade on the centralized exchange (BSE/NSE) with no direct contact between buyer and seller.
What are off-market transactions?
An off-market transaction is a trade agreed by two parties where the funds and bonds are directly transferred without the intervention of an exchange or a clearing corporation. Digital platforms use a wallet mechanism to perform these transactions.