Investing in bonds can be a complex process. This is because unlike stocks, bonds primarily trade in the over the counter (OTC) market where there is no centralized pricing entity. Instead, prices are negotiated between brokers either over the telephone or via the Internet. Bond brokers are there to streamline the process of buying and selling corporate bonds. Their job is to serve as intermediaries between buyers and sellers of bonds, primarily in the institutional market, but also to individual investors.
Bonds trade in the fixed-income market and provide a steady stream of revenue to investors in the form of interest and principal payments. These trading instruments are widely considered to carry less risk than stocks, because in order for investors not be paid, a company or government must default or file for bankruptcy. Stocks, which are traded by stock brokers, can be much more volatile and offer investors a chance for greater rewards but also more severe losses.
Although bonds tend to be less risky than stocks, a drawback is that because these securities do not trade on a formal exchange, there is no central marketplace to determine or verify a bond’s value. Instead, bond brokers are largely responsible for determining prices. They do this by purchasing bonds from one institutional investor and selling them to another.
The difference between the buy and sell price is called a spread, and this difference is kept by bond brokers as a profit. A spread is masked because it is included as part of a bond’s price, and bond brokers are not required to disclose how much they are earning on each trade. In the United States, a bond broker is required by law only to earn a spread that is fair, despite the fact that oversight like that can be interpreted subjectively.
There are ways to research bond prices to get a sense of what the market value is for a security rather than just taking the word of a bond broker. The Internet is a valuable tool for researching past trades. In the U.S., the Financial Industry Regulatory Authority provides some pricing information on bond deals. By researching past deals, an investor can learn the going price for a specific bond or for one with similar trading characteristics to the one he or she is interested in trading. As a result, an investor is better able to determine the true value of a bond and profits being generated by bond brokers.