7.5 Bond Market Trading

Bond Market Trading

Describe How Bond Trading is Conducted

Fixed-income trading activities in the investment banking business take place in two separate areas of operation: the sell side and the buy side. The two sides sometimes operate out of separate institutions, but some large investment banks encompass both a sell-side desk and a buy-side desk.

Sell Side vs. Buy Side

Sell Side: The sell side of the bond market largely consists of dealers and investment banks that facilitate transactions, provide liquidity, and set prices for securities. They engage in underwriting and market-making activities, often selling to buy-side firms. They earn income through commission, spreads, or fees.

Buy Side: The buy side typically includes entities that are purchasers of securities, such as mutual funds, pension funds, hedge funds, insurance companies, and proprietary trading desks within large banks. Their main objective is to invest funds to generate returns for clients or the institution’s portfolio.

The Trading Process

The bond trading process involves several key steps:

1. Order Receipt: Orders from buy-side institutions are received by the trading desk on the sell side. Orders may be submitted electronically or over the phone.
2. Quotation and Negotiation: The sell-side desk provides quotations based on current market conditions. Prices are often negotiated between the buy-side and the sell-side traders.
3. Execution: Once terms are agreed, the trade is executed. Trades may be conducted over-the-counter (OTC) or on electronic trading platforms.
4. Settlement: The settlement process involves transferring the security and funds between buyer and seller. This usually happens within T+2 (trade date plus two business days).
5. Confirmation and Reporting: While the trade is settled, confirmations are sent to both parties and the trade is reported to regulatory bodies.

Frequently Asked Questions

Q1: What is the main difference between the sell side and the buy side in bond trading?

A1: The sell side comprises dealers and investment banks that provide liquidity, facilitate transactions, and set prices, while the buy side includes investment management firms purchasing securities for portfolios.

Q2: How are bond trade prices quoted?

A2: Bond trade prices are quoted as a percentage of the bond’s face value. For instance, a bond trading at a price of 102 would mean it is selling for 102% of its nominal value.

Q3: What are OTC Markets?

A3: Over-the-counter (OTC) markets are decentralized markets where securities are traded directly between parties rather than through a centralized exchange.

Key Terms and Definitions

Fixed-Income Trading: The buying and selling of debt securities, primarily bonds, to derive a consistent flow of income.

Underwriting: The process through which an investment bank raises investment capital from investors on behalf of corporations and governments issuing securities.

Market-Making: Activities undertaken by dealers to provide liquidity by buying and selling financial instruments from their own accounts.

Order Receipt: The initial stage in the trading process where orders are submitted by buyers or authorized intermediaries.

Settlement: The process of transferring ownership of a security from seller to buyer and the corresponding transfer of funds.

Key Takeaways

• Bond market trading involves the coordination between sell-side and buy-side entities, each with distinct functions and objectives.
• The trading process comprises several steps, from order submission to settlement and reporting of the trade.
• Understanding the terminology and processes involved is crucial for efficient bond market trading.
• Both OTC and electronic platforms are utilized in bond trading, offering different degrees of transparency and regulatory oversight.

Charts and Diagrams

    flowchart LR
	    A[Order Receipt] --> B[Quote and Negotiation]
	    B --> C[Execution]
	    C --> D[Settlement]
	    D --> E[Confirmation and Reporting]

In this section

• 7.5.1 Sell Side
  Understand the sell side of fixed-income trading, including the roles of investment bankers, traders, and sales representatives. Learn about their responsibilities and how they contribute to the financial markets.
• 7.5.2 Buy Side
  Understanding the buy side of fixed-income trading, focusing on portfolio managers, traders, and the institutional clients they serve.
• 7.5.3 Buying Bonds Through Investment Dealer
  Explore the intricate process of buying bonds through an investment dealer, covering both large institutional and smaller firms, role of inter-dealer brokers, and essential techniques for efficient bond trading.
• 7.5.4 Mechanics Of Trade
  Learn the comprehensive mechanics of non-electronic securities trade, including trade tickets, clearing and settlement, calculating accrued interest, and understanding bond indexes as described in the Canadian Securities Course.