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Summary
- Unlisted bonds trade over the counter instead of a securities exchange and are tracked using pink sheets or OTCBB.
- Among the various bonds available, corporate bonds issued by private and public companies trade on OTC.
- Bonds are less risky than stocks, and bond prices are determined by factors including demand and supply, term of maturity and credit quality.
Unlisted bonds are the ones that trade over the counter (OTC) instead of any exchange or other listing facilities. These bonds are tracked through pink sheets or over the counter bulletin board (OTCBB).
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Bonds are debt instrument issued by the government and corporations to raise capital.
Why do bonds trade over the counter?
Unlike shares that transact on stock exchanges, most corporate bonds trade over the counter as these come from different issuers. Each issuer has different bonds with different maturities, coupon, nominal values, and credit rating.
Hence, if an investor wants to purchase a bond, they need a broker who, in most cases, can arrange the specific bond.
What kinds of bonds generally trade over the counter?
Generally, corporate bonds issued by private and public companies trade on the OTC market instead of getting listed on the stock exchange. Further, transactions involving exchange-traded bonds are done over the counter.
The companies issue corporate bonds to fund their capital expenses. These appear attractive to investors as they offer improved yields compared to government bonds. Also, corporate bonds are pretty expensive as compared to government bonds.
The bonds that trade over the counter vary in terms of the level of liquidity. Thus, it gives investors ample opportunities to buy and sell bonds at a fair price. Other than this, corporate bonds that trade OTC offer investors a constant flow of income as they are rated as per the credit record of the issuing company.
Why most bond trade over the counter?
Bonds trade over the counter primarily for three reasons:
- Compared to equities, debt securities are large in number. Hence, they are less concentrated than equity.
- The average size of the bond market is comparatively greater than for an equity trade.
- Unlike equities, bonds rarely trade, so there is seldom a continuous supply of buyers or sellers looking to trade sufficient to maintain a central pool of investor provided liquidity.
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Pros and Cons of Bonds
Pros
- Bonds are relatively less risky than stocks.
- Investors have wider options to choose from.
- Bondholders get preference over shareholders in case the company is under the bankruptcy phase.
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Cons
- Since they are less risky, bonds provide a lower return on average as compared to stocks.
- Ordinary investors may find buying bonds less accessible.
- Bonds are highly prone to credit default risk and interest rate risk.
What influences the price of a bond?
Three major factors determine the price of a bond on the open market. These are
- Demand and supply.
- Term of Maturity.
- Credit quality.
Demand and supply
In the open market, the price of the bonds directly depends on the demand and supply for the bond. Further, the price of the bonds is decided based on the project cash flow to present using the discounting rate method.
Term of Maturity
Bond’s term maturity is the duration during which the bondholder would get interest payment on the investment. At the time of maturity, the bondholder would be repaid its par or face value. However, if the bond has a put or a call option, there might be a change in the term to maturity.
Credit Quality
Bond price is directly linked to the quality of the bond issuer during and after the bond issue. It is seen that the Companies with lower credit quality provide improved interest rate to offset investor to accept greater default risk.
