Transparency and Corporate bond market

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Transparency and Corporate bond market

Introduction:

This article brings into picture the operations of individual markets and analysis different patterns of behavior in the market for different goods and services along with different determinants and the effect of supply and demand, government regulations, the structure of the market and strategic behavior.

US Bond market:

The US bond market as per 2006 is estimated to be $5.37 trillion, which is highly governed by Treasury bills or municipal bonds, the corporate bonds amounted to be $470 billion. Corporate bonds are one of the major means with which the corporates raises funds. US corporate bond market has undergone many changes after the introduction of Transaction Reporting and compliance engine. With this it was compulsory for all the corporates to issue the bond through National Association of Security dealers. With a focus on this the security market became transparent.

Corporate bonds are the bonds that are issued by corporations and are exposed to default risk. There are different risks that are entailed by the corporate bonds which is highly dependent on issuing company’s characteristics and on the terms of the specific bond.

This paper brings into picture different aspects so as to increase the transparency in the corporate bond market. The corporate bond is the bond which makes coupon payments to the holder on the face value of the bond. All these bonds have a specified maturity date, after the expiry of which the issuing company pays back the value of the bond. This is one of the major means to raise capital. The rates of the bonds are highly affected by the economic conditions and the market rates along with the market perception. All these bonds which are sold in the market needs to be registered with the Securities and Exchange Commission. The credit worthiness of all these bonds are evaluated by different credit rating companies which tells about the prospects of the company. All the bonds and debt obligations has some investment grade. The bonds which are not rated are generally considered as the junk bond or speculative bonds. Bond is usually rated as ‘BB’/ lower, because of the risk of high default. These bonds can be purchased for some purposes which are speculative. These bonds offer rate of interest which is three to four percent points higher when compared to any safe government issues.The trading of the corporate bonds is done in the OTC i.e. over the counter market in NYSE. Apart from this the bonds are also sold in the dealer market through which the investors purchases bonds.

The two specific risks associated with bonds are as follow:

Interest Rate Risk: There is an inverse relation between the bond prices and interest rates. The fall in the prices of bonds lead to the rise in the interest rate and rise in the interest rate leads to the fall in the price of bonds.

Inflation Risk: The investor receives a rate of return either fixed or variable for the duration of the bond. But the rise in the inflation or cost of living leads to decrease in the purchasing power and it results in the negative rate of return.

There is an inverse relation between the volatility of the interest rates and the price of the bonds. The increase in the volatility will lead to decrease in the price of the bonds. The bondholders rely on the interest payments as one of the source to recover the bond investment. Therefore, increase in the volatility will cause the investors to pay less for a non-callable bond that had high convexity. There is an inverse relation between rate of return and bond prices. If the market rate of return increases, then the current holdings of bond will have lower price as the securities with high rate of return will have more demand. If the there is a decline in the market interest rate, then the value of current holdings will increase, which will lead to increase in bond’s price.

To increase the transparency of the trading of the bonds, it is compulsory for all the bond dealers to report all their transactions to the National Association of security dealers as per the regulations of TRACE. With the regulations, the transparency of the trading of the bonds has increased which has highly benefited the investors. With this transparency, there has been a substantial reduction in the bid ask spreads that needs to be paid by the investors. This has benefited the investors to a great extent, but with this the bond dealers have experienced reduction in the employment as well as their compensation and they are focusing more on syndicate bank loans and credit default swaps which has higher pay as compared to the corporate bonds. The main complaint of the dealers with the trading if bonds is the decrease in the cost of the bonds along with the decrease in the corporate bonds.