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Primary Versus Secondary Markets – The Life Of A Bond

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Introduction

 

 

Many investors may have a rudimentary knowledge of the time and effort placed into creating a bond to be issued to the public to lend to authoritative entities such as governments, municipalities, and corporations. But just how exactly are bonds’ created? Who creates the key components of each individual bond such as the bond yield or maturity? In order to answer these questions you must first have a general understanding of the main topic of today’s lesson: Primary Versus Secondary Markets – as I will be answering these burning questions and much more as we analyze the life cycle of a bond.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Primary And Secondary Bond Markets

 

 

Bonds are sold in primary and secondary bond markets, with the primary market for small and newly issued bonds.

The secondary market, on the other hand is where investors can buy and sell bonds’ that have already been issued. A majority of bonds’ are bought and sold here.

As you may already know, a bond is issued by an entity like a corporation, government or municipalities to raise money.

But issuing a bond is considered to be a long and lengthy process, this prompts the issuer to hire an underwriting company to help – to handle the tedious manual work no less.

The underwriting company and the entity will determine the bonds’ details, including the length to maturity and its coupon rate. The coupon rate itself is determined by a number of factors such as competing bond coupon rates and the issuing entities credit ratings.

 

 

After determining the bond details, the underwriting company will form a syndicate of bond sellers, who will pay the issuing entity for the bonds’ and sell the bonds’ to their customers.

 

 

If you purchased a newly issued bond, you may be able to do so at face value. However, if the bond was in the secondary market, you’d probably pay a different price.

If you purchase a bond at a price different than its face value, you receive a different rate of return than its coupon rate. This is because a bonds’ coupon payment is fixed – and while a bond’s price may fluctuate, its payments may remain the same.

For example suppose you purchase the same $1000 bond for less than face value with an original 5% coupon rate. Because you paid less than face value the bonds’ 5% coupon rate will offer a real rate of return of 5.03% – this adjusted rate of return in what is known the yield to maturity.

The yield to maturity accounts for the bonds’ current price, coupon rate, and time left until maturity. The
yield to maturity allows you to compare new bonds’ to older bonds’, which is important when buying or selling bonds’ in the secondary market.

Once the syndicate of bond sellers sells the newly issued bonds’ to their sellers, the public is now free to buy them as they will – this the transition from the primary market to the secondary market.

 

 

The secondary market is simply where the current bondholder sells bonds to investors.

When purchasing a bond in the secondary market, its important to consider the bonds’ details, including its price, the yield to maturity, and rating to name a few.

When comparing bonds’ of a similar yield to maturity, always look for ones with the highest rating.

After finding a bond that has a yield to maturity and rating that your comfortable with, you can finally go ahead and purchase it.

 

 

Quick Recap

In Review……

Primary Versus Secondary Markets

  • Bonds are sold in primary and secondary bond markets, with the primary market for small and newly issued bonds
  • The secondary market, on the other hand is where investors can buy and sell bonds that have already been issued. A majority of bonds’ are bought and sold here
  • But issuing a bond is considered to be a long and lengthy process, this prompts the issuer to hire an underwriting company to help – to handle the tedious manual work no less
  • The underwriting company and the entity will determine the bonds’ details, including the length to maturity and its coupon rate. The coupon rate itself is determined by a number of factors such as competing bond coupon rates and the issuing entities credit ratings
  • After determining the bond details, the underwriting company will form a syndicate of bond sellers, who will pay the issuing entity for the bonds and sell the bonds to their customers
  • Once the syndicate of bond sellers sells the newly issued bonds to their sellers, the public is now free to buy them as they will – this the transition from the primary market to the secondary market
  • The secondary market is simply where the current bondholder sells bonds to investors

 

 

And it is as simple as that. The creation of a bond from any entity alone is a long and tedious process, but I did my best to try to explain the process in its most simplest form in order for readers to grasp the general concepts involving the bond markets and the distinction between the primary and secondary markets. Primary and Secondary markets does not only apply to the bond market alone, but to other markets as well – which practically have the same merit with regard to other financial assets.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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