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Sunday, July 8, 2007

Investment: The Profile of Bond Markets

Investment banking firms specialize in the issue of long-term corporate, municipal, and foreign bonds as well as common stock. A corporation proposing to sell securities arranges with an investment-banking firm to underwrite the securities. The investment-banking firm undertakes to buy the entire issue at an agreed-upon price. It then sells the issue piecemeal to life-insurance companies an pension funds in the case of foreign an corporate bonds; or to banks, marine, fire, and casualty companies, and wealthy individuals in the case of municipal bonds. If the issue is a large one, the investment-banking firm may form an ad hoc group called a syndicate, joining with other investment banking firms and brokerage houses to share the risk. The syndicate tries to sell the bonds at a price a little above the buying price. If they have guessed the market correctly, they sell out the issue quickly and make money. When they misjudge the market, they may have to sell part of the issue at a loss. To protect investors, the Securities and Exchange Commission (SEC) requires that a corporation provide much information when it sells a large bond issue. Providing this information and meeting all the required government regulations is expensive. Some corporations sell a whole bond issue directly to insurance companies or pension funds at a negotiated price. These sales are called private placements. By using this method, the seller avoids paying the underwriter’s profit and the cost of SEC registration for a public issue.

Competitive bidding is usually required by law for the bond issues of state and local governments and public utilities. Competition among investment banking firms and brokerage houses for these issues is very sharp. Sometimes the interest rates offered differ only in the fourth decimal place. Competitive bidding is, of course, inconsistent with private placements.

The secondary markets for corporate and municipal bonds are limited. Most issues are held to maturity. There is some trading in old bonds on the New York Stock Exchange, and financial institutions sometimes trade bonds privately. Municipal bonds may be resold through brokers but the market is poorly organized because there are so many relatively small issues outstanding.

Because Congress has placed limits on the maximum interest rate payable on long-term bonds, the Treasury has been able to make only a few long-term issues in recent years. Nonetheless, there are large amounts of long-term U.S. Treasury securities outstanding. They are widely held and actively traded. The dealers who are so active in the short-term market also trade in long-term Treasury securities and the secondary market is better organized than the other bond markets.

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2 comments:

Narathan said...

Bond always used as an alternative to get a fresh cash in the long term payment.

Suray said...

[Narathan] you're right!

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