April 28, 2011
Chuck from Charleston, SC:
I went to sell a corporate bond from my portfolio and discovered I couldn’t get anything close to what was marked in my account. Why is this?
There are a few reasons. First, be sure that you are looking at a current price for your bond. Your most recent account statement may still be outdated. If you are looking at an online snapshot of your portfolio, chances are that your corporate bond may only reflect the previous day’s close (if it’s during market hours), unlike stocks or ETFs, which your broker/custodian will generally have fairly up to date prices displayed (maybe real-time).
However, the most likely cause of your frustration is simply the lack of liquidity of your security. One symptom of a less liquid security is a large spread between the prices that you would be able to purchase the security (offer price) and the price at which you could sell the security (bid price) in the open market. We are often used to the highly liquid markets of equity securities, which frequently trade with a 1 cent spread between bid and offer. Corporate bonds can trade as wide as several dollars (points) between bid and offer. We have even seen specific bonds trade more than 10 points between bid and offer!
The price reflected by your broker/custodian is most likely coming from an independent pricing source. They do not necessarily account for a specific side of the market (buyer or seller). They also do not account for the size of your specific position, which can contribute to the disparity in your observation.
While some corporate bonds trade every day, some don’t trade very frequently. We have seen bonds that literally haven’t traded in several months! So, the pricing sources are making an educated guess on their value based on other bonds that have traded more recently. It may be that the pricing source used by your broker/custodian doesn’t accurately reflect current market buyers and sellers for your specific bond.
Generally, less frequently traded bonds are less liquid, and carry larger spreads between buyers and sellers since less information is available about trading history. Smaller size bonds may also be more difficult to sell and thus receive lower prices (bids). Really large positions might also have problems, but this is not common in a retail setting.
A good example of a corporate bond that has a large spread between bid and offer is a bond issued by Anheuser Busch that matures in 2031 and pays a coupon of 6.8%. Looking at the table below, you will see that this bond traded 9 times on February 18th, though the price varied materially. This is an example of a bond with a wide bid/ask. If you wished to buy this bond on 2/18, you would have paid a much higher price than what you could sell where you could sell it at the same point in time. Even if your broker valued your security in the middle of this range, it would create quite a surprise when you went to sell it!
Another example is a municipal bond issued by a Township Board of Education in Verona, NJ. You can see in the table below that this bond only traded 2 times in the last 6 months. It would be difficult to even know a realistic price for this bond considering how long ago it traded.
We hope that helps and provides fodder for discussion. Please let us know if we can be of further service!
The Friedenthal Financial Team
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