Primary and Secondary Bond Markets

Understanding Primary and Secondary Bond Markets | CFA Level I Fixed Income

Welcome to our dive into the world of primary and secondary fixed-income markets! Let’s make sense of how bonds are issued and traded, and why these markets are crucial for both issuers and investors.

The Primary Bond Market Explained

Think of the primary bond market as the birthplace of new bonds. Here, issuers such as corporations, governments, and other entities sell new bonds directly to investors. The goal? To raise capital efficiently. It’s somewhat akin to a company’s initial public offering (IPO) in the stock market, but for bonds.

Debut Issuers vs. Repeat Issuers

When entities issue bonds for the first time, they’re known as debut issuers. These can be newly formed companies, mature businesses with stable cash flows, or even governments stepping into the international debt market. On the flip side, repeat issuers are those familiar faces in the bond market, often enjoying a quicker issuance process thanks to their established reputation.

Roadshows and the Issuance Process

Before a bond can make its market debut, there’s a slew of preparations. Issuers and underwriters embark on roadshows to woo potential investors, detailing the bond’s purpose and repayment sources. For repeat issuers, this process is streamlined, focusing on either launching new issues or reopening existing ones to increase their size.

An illustrative timeline for issuing new corporate bonds might look like this:

  • Underwriters and issuer decide to launch the transaction.
  • Announcement of the transaction with details pending.
  • A call for investors to express interest.
  • Closing the order book and finalizing the transaction details.
  • Allocation of bonds to investors.
  • Pricing of the transaction and setting the coupon.
  • Distribution of the final term sheet, with bonds trading soon after.

Navigating the Secondary Bond Market

After bonds are issued, they enter the secondary market, where they are traded among investors. This market’s liquidity varies significantly across bond types and issuers, heavily influenced by the bid-ask spread—the narrower the spread, the more liquid the bond.

Secondary bond market - relationship between spread and liquidity

Liquidity and Trading Dynamics

Highly liquid bonds, like the most recent issues of developed market sovereign bonds, have very tight bid-ask spreads. Corporate bonds from frequent issuers with strong credit ratings also enjoy high liquidity and tight spreads. Conversely, bonds from infrequent issuers or those with deteriorating credit quality may see less trading activity and wider spreads.

Distressed Debt: A High-Risk, High-Reward Game

Distressed debt presents a unique scenario. These bonds come from issuers near or in bankruptcy and trade at prices far below par, reflecting the high default risk. While some investors steer clear, others, particularly those with a high-risk appetite, might find distressed debt an enticing opportunity for significant returns.

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