Free Article Review About Transparency And The Corporate Bond Market
Corporate bonds refer to debt securities that public and private corporations issue out. They sell them to investors with the aim of raising money for various purposes. The price at which bonds trade among investors and dealers depend on economy-wide interest rates and how the market perceives the likelihood that the corporation will make the promised payments. When an investor buys a corporate bond, it is like they are lending money to the company that promises to pay back the principal on a specified maturity date. Before the maturity date, the company pays the investor at a stated rate of interest. These payments are taxable. Contrasting stocks, bonds do not provide the investor with ownership of the issuing company (Sifma, 2013).
It is a must that bonds sold to the United States investing public be registered with the Securities and Exchange Commission. The corporations issuing bonds are required to hire credit-rating agencies in order to have their credit-worthiness evaluated. Trading in corporate bonds can rely on dealers, limit orders or both. Earlier, corporate bonds were mostly traded on the New York Stock Exchange limit order market. During the 1940s, the trading migrated largely to a dealer oriented over-the-counter market. The migration is said to be as a result of growth in bond trading by institutional investors such as endowments and pension funds (Bessembinder & Maxwell, 2008).
Before the introduction of TRACE, corporate bonds transaction prices were only available to parties involved in a certain trade. Institutional investors mostly relied on third party pricing services to provide end-of-day information. Individual investors had less access to information. The main source of data about corporate trading before the introduction of TRACE was the National Association of Insurance Commissioners.
In 2001, rules by the Securities and Exchange Commission got approved. The rules required the National Association of Security Dealers to compile data on all over-the-counter transactions regarding corporate bonds trading. The dealer is required to identify the bond being traded and to report the date and time of the execution, trade size, trade price and whether the bond was sold or bought in that transaction. Not all the information got provided to the public. After the introduction of TRACE, traders were required to report trades within 15 minutes. The introduction of TRACE has had major effects on the market liquidity and transparency. Investors have benefited from an increase in transparency due to the reduction of bid-ask spreads that they pay to dealers to complete the transaction. Dealers have experienced reduction in employment and compensation since the traditional dealers’ activities have shifted to alternate securities. One of the most complained effects of TRACE is that dealers no longer share the results of their research (Finra, 2015).
Bessembinder, H., & Maxwell, W. (2008). Markets: Transparency and the Corporate Bond Market. Journal of Economic Perspectives, 22(2), 217-234.
Finra. (2015). Independent TRACE Studies. Retrieved from http://www.finra.org/Industry/ContentLicensing/TRACE/P117112
SIFMA. (2013). Types of Bonds. Retrieved from http://www.investinginbonds.com/learnmore.asp?catid=5&subcatid=18
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