Bond Markets

Corporate bonds are traded primarily in the over-the-counter market. Most bonds are owned by and traded amount the large financial institutions (for example, life insurance companies, mutual funds, and pension funds, all of which deal in very large blocks of securities), and it is relatively easy for the over-the-counter bond dealers to arrange the transfer of large blocks of bonds among the relatively few holders of the bonds. It would be much more difficult to conduct similar operations in the stock market among the literally millions of large and small stockholders, so a higher percentage of stock trades occur on the exchanges.

Information on bond trades in the over-the-counter market is not published, but a representative group of bonds is listed and traded on the bond division of the NYSE. Figure 7-6 gives a section of the bond market page of The Wall Street journal for trading on September 18, 1996. A total of 310 issues were traded on that date, but we show only the bonds of Cleveland Electric company. Note that Cleveland electric had three different bonds that were traded on September 18; the company actually had more than ten bond issues outstanding, but most of them did not trade on that date.

The bonds of Cleveland Electric and other companies can have various denominations, but for convenience we generally think of each bond as having a par value of $1,000 this is how much per bond the company borrowed and how much it must someday repay. However, since other denominations are possible, for trading and reporting purposes bonds are quoted as percentages of par. Looking at the first bond listed in the data in Figure 7-6, we see that there is an 8³/₄  just after the company’s name; this indicates that the bond is of the series which pays 8³/₄ percent interest, or 0.0875($1,000)=$87.50 of interest per year. The 8³/₄ percent is the bond’s coupon rate. The Cleveland Electric bonds, and all the others listed in the Journal, pay interest semiannually, so all rates are nominal, not EAR rates. The 05 which comes next indicates that this bond matures and must be repaid in the year 2005; it is not shown in the figure but this bond was issued in 1970, so it had a 35 year original maturity. The 8.9 in the second column is the bond’s current yield; Current yield =$87.50/$980=8.93%, rounded to 8.9 percent. The 477 in the third column indicates that 477 of these bonds were traded on September 18, 1996. Since the price shown in the fourth column is expressed as a percentage of par, the bond closed at 98 percent. Which translates to $980, the same as the previous day’s close.

Coupon rates are generally set at levels which reflect the “going rate of interest” on the day a bond is issued. If the rates were set lower, investors simply would not buy the bonds at the $1,000 par value, so the company could not borrow the money it needed. Thus, bonds generally sell at their par values on the day they are issued, but bond prices fluctuate thereafter as interest rates change.