Bid, Ask, and Spread
Rather than trading on organized exchanges, bonds trade in a huge over-the-counter market, consisting of networks of independent dealers. Since there is no control trading place and literally millions of issues that may only trade infrequently, pricing information for bonds is not as readily available as it is for stocks. To determine the commission you are paying to buy or sell a bond, you need to understand the significance of bid, ask, and spread.
Bond prices are quoted in pairs ― the bid price is the bond’s selling price and the ask price is the bond’s purchase price. The bid price will be lower than the ask price, with the difference between the two representing the spread, or commission. Prices quoted in papers are market prices, while prices quoted to individual investors are often wider than those prices.
Commissions can vary for a variety of reasons, including the bond’s size, the type of bond, the bond’s maturity date, the bond’s credit quality, the directions of interest rates, demand for a specific bond, and the dealer’s cost and markup. As a general rule, lower-risk bonds that are in high demand have lower commissions, while higher-risk bonds with less demand have higher commissions. Typically, commissions can range from 1/2 % to 1% for actively traded Treasury securities to as much as 4% for inactively traded bonds.
Determine the spread before purchasing a bond. If you are purchasing a bond that you may need to sell before maturity, be cautious of a bond with a large commission. You may find that you have trouble selling the bond, and you could pay another high commission when selling.
Copyright © Integrated Concepts 2013. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.