Bond investing is considerably more complex than stock investing. In effect, corporate bonds are an IOU from a corporation, promising to return the money with interest. The bond market is also known as the debt market because companies are using debt (the bonds) to finance their operations.
Historically, the corporate bond market has been an institutional one, with little room for small investors. Bonds were often bought and sold in the closed world of experienced insiders and experts. This is slowly changing as stock exchanges begin to implement bond trading.
Learn more about the bond markets and how to buy newly-issued corporate and older bonds.
The New Bond Issue Market
The corporate bond market has two distinct levels. The first, or primary market, represents new bond issues. When a corporation decides to sell bonds to raise capital, it negotiates with investment bankers and large institutional investors to place those bonds in the market.
The pricing of these new issues, which are comparable to initial public offerings of stock, tends to be easier to understand. And everyone who buys a new issue bond pays the same price, known as the offering price.
Purchasing a primary bond offering is quite tricky—it's similar to buying stock in an IPO before the start of public trading.
To get a hold of a primary bond, you'll need to have relationships with someone at an institution that manages the primary bond offering. Small investors won't be able to play this game easily.
The chart below shows Moody's AAA Corporate Bond Yield from 1919 through 2020.
The Secondary Market
The secondary bond market consists almost entirely of what is known as an over-the-counter (OTC) market. In OTC bond markets, most trades are conducted on closed, proprietary bond-trading systems or via phone.
The average investor can participate only through a broker. More importantly, bond pricing on the secondary market can be complicated to track and understand.
Research the Secondary Market
If you're interested in buying corporate bonds on the secondary market, do enough research to know if you're paying a reasonable price for the bond. In particular, look at recent bond sales to calculate the "mark up" or "spread" on a bond.
The spread denotes the difference between what a bond broker paid for a bond and the price they want for it.
Before you agree to buy a bond through a broker, look at the recent quotes for the bond in question or a similar issue. Then make an approximate calculation of how much of a spread your broker is charging.
Unlike stock commissions, the bond spread is built into the price of a bond, making it nearly impossible for you to know how much profit the bond salesman makes.
After you've decided what spread or commission you're likely to pay if your broker doesn't hold the bond but promises to buy it for you in the market, your work's just getting started.
Buying a corporate bond requires a much higher level of due diligence than buying a share of stock. Follow the advice of trade associations that monitor the market and research your financial professional thoroughly.
The Public Exchange
The series of scandals among bond salespeople has led to increased transparency in how the industry operates. Bit by bit, the bond market is evolving and beginning to resemble the stock market.
Today, it's possible to buy and sell bonds on a public exchange. The New York Stock Exchange launched its NYSE Bonds system in 2007, replacing the older Automated Bond System with something that works better for small investors.
The number of bonds sold through NYSE Bonds has grown significantly since the launch, with new bond issues added regularly. Nonetheless, exchange-traded bonds remain a small percentage of the overall market.
Bonds can be a wise investment, although prospering in the corporate bond market requires a considerable amount of diligence and effort. Consider bond mutual funds or government-backed debt as alternatives that offer the safety of bonds without the complications of buying individual corporate bonds.
Bond Market Regulatory Agencies
When trading bonds, it helps to know which agencies regulate the markets and find information that can help protect you from unethical brokers or traders. Limiting your trades to regulated exchanges significantly reduces your exposure to risk and unscrupulous practices.
The Financial Industry Regulatory Authority, a non-governmental regulatory agency, now offers pricing information on recent bond transactions through its Trade Reporting and Compliance Engine (TRACE) system, offering some visibility on spreads. The authority also provides alerts for investors to help them keep their money safe.
Each of the exchanges you can trade on has regulatory programs to ensure trading is conducted fairly and honestly and complies with federal, state, and exchange regulations. For example, the NYSE Bond market is regulated by the NYSE Regulation, which oversees all NYSE trade activities. Be sure to check for information on the websites of the exchanges you decide to trade on.