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How are bonds issued

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    Benton Li
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The primary market is the place where new-issued bonds are distributed and traded. It is just a conceptual place, not like a real place like NYSE.

Here, new bonds are announced, priced, distributed, and paid for.

There are there main types of routes:

  • Privately negotiated public bond deals: Terms are negotiated by financial institutions for corporate and other non-government borrowers. e.g. public bonds issued by IBM (it’s public)
  • Private placement of nonpublic debt: issued directly to institutional investors. e.g. private debt issued by Burger King (surprisingly it’s private)
  • Public auction of government securities. e.g. 10-Year T-Bond

Advanced reading

Pricing of corporate bonds

The price, term, coupon rate, and amount, are negotiated by various market players. An example of the negotiating structure is shown below:

Corporate Borrowers (e.g. Cisco)

⇅ (negotiation)

Financial Institutions (e.g. Goldman Sucks)

⇅ (negotiation)

Bond Investors (e.g. BlackRock)

Coupons can be fixed or floating:

  • Fixed: this rate is priced on a yield spread basis vis-a-vis the government securities. The spread exists because compared to a government, corporate is more likely to go bankrupt. They don’t have Congress that can make laws to rob tax.
  • Floating: this rate is determined by certain indexes like Shanghai Inter-Bank Offer Rate (Shibor).

More About Private Placement

My father gave me a small loan of a million dollars

— Donald J. Trump

Well, it is a private placement? Technically yes. But, his daddy cannot resell this bond. Who’s gonna voucher for this? Does Donny’s word count?

But if Donny gets a $1M loan from Morgan Stanley, I will probably think about it, because that will be under a certain level of regulation. If something goes wrong, FINRA will go after Morgan Stanley’s ass.

It is true that private placement is less regulated, therefore less liquid. Nevertheless, it provides diversified credit risk opportunities. Also, some investors dgaf to liquidity anyway: they care about the high yield and they have faith in the borrowers.

More:

  • US Government Bond Issuance (Coming soon)
  • UK Government Bond Issuance (Coming soon)