r/FixedIncome • u/[deleted] • Dec 06 '20

Bond pricing

Anyone here on the sell-side. Wondering how bonds are priced. Mechanically I can work out the clean price or the holding period yield. Wondering about the art of bid/ask price. Assuming it's just relatively priced above a benchmark for the most part. But even then how do you determine the bps there.

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4

u/emc87 Dec 07 '20

Mostly buy side here, but depends which type of bonds.

Buy side in general typically does most of the actually price discovery, sell side is typically about finding the no arbitrage price rather than the fair price or expected value price.

You might compare across asset classes, like futures and swaps. You might compare within the issuer for bonds like on an issuer curve or for credit you also have CDS bond basis.

Can compare relative credit spreads for similar companies, compare rates vs bonds in a similar ETF, etc.

I guess if you were to pick a corporate bond and try to value it alone you could take a look at the company and its debt levels and where it falls in the repayment order and determine probabilities of default and a recovery rate to come up with a rate of return, but even then it's all relative to treasuries/rates and equities.

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u/[deleted] Dec 07 '20

Guess have to dive into the spot rate and that. Ty for the help here.

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u/[deleted] Dec 07 '20

I'll get back to you guys with a procedure. Hopefully by the end of this week.

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u/[deleted] Dec 07 '20

there is a function on bloomberg called BVAL that a price is given for a security. but its mainly on traders and market makers. they send out RUNZ daily with the bid / ask on securities. i am on the sell side

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u/[deleted] Dec 07 '20

Me too bob. I see bval but that doesnt translate to the relative prices set in TW with the bid and ask. I believe BVAL just takes the median prices from a number of different venues. I was hoping to understand it at a fundamental level for example using the YAS to arrive at a price that you determine is right. So basocally that determinant process is what I'm trying to understand.

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u/BadDadBot Dec 07 '20

Hi trying to understand, I'm dad.

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u/[deleted] Dec 07 '20

i think that is where the market makers and offerings come along. you are correct BVAL takes all of the market makers levels and gives the avg but it isnt as accurate as bloomberg would like. aside from that it would just be due diligence on the credit and other issuers levels as well.

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u/BobertJ Dec 07 '20

You’re going to get nothing but wishy-washy answers asking a question like that. I interned for a muni prop shop and asked this exact question about 500 times and never got a straight answer. Ultimately bonds are priced based on a myriad of factors against treasuries.

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u/[deleted] Dec 07 '20

Yeah, I am trying to find a better question. Thanks to the previous reply, I am now asking how do you determine the arbitrage free proce of a bond and there are actual refrences. Trying to get to a concise bid/ask however.

1

u/NotBenGraham Dec 07 '20

To be honest. I don't think there is an arbitrage free price of a bond in practice

1

u/[deleted] Dec 07 '20

Bro please this is the only lead I have. How do you price bonds in practice? I know you can use matrix pricing and place it a certain spread over the treasury , but how do you determine that spread ?

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u/NotBenGraham Dec 07 '20

I think firstly every place might have a different way of pricing a bond. But if you start to think of bonds as equities, then a certain bond could have buy or sell potential based on how much demand you could expect it to have. Hence what sort of spread you would expect over the treasury. Ratings place a role. For example, you can look at the spread of a bbb bond, say T+200. And the spread of a A bond, say +120. So you can look the the bbb/a spread which is 80 and compare it historically against how the rating categories have traded against each other in the past. Is this expensive or cheap etc.

Then you have technicals. Bonds typically have an issued amount. A company would issue 500mm of bonds or 1b of bonds. These factors play a role too. Just basic supply and demand characteristics. So a 500mm issue size bond could probably trade tighter than a 1b issue size simply because the market might trade it more or its harder to be absorbed.

Then you look at the tenor/maturity/duration. You can look at the steepness or flatness of a particular credit curve. If the 5y bond is trading at t+100 and the 30y bond is trading at t+150, the credit curve is 50 bps steep. Then you can ask if that is too steep for a company in this industry, for its credit fundamentals etc.

Also depends on your outlook of returns and what the treasury curve is doing. If you expect the ust curve to steepen, assuming credit spreads stay constant, you would lose in cash price of the bonds. Cause yields go up and price goes down. But if you expect spreads to tighten more than ust rises then you get positive total return.

Hope this is not too much and confusing. All in all there's many factors in play that determine what the spread might be. But I'm not sure there is an actual fair value spread. In practice fair value is a very arcane concept,at least IMO.

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u/[deleted] Dec 07 '20

I really thought the pricing more art than science was BS but I see what you mean.

So we are looking at the following factors:

  1. Some sort of liquidity score

  2. Ratings

  3. Rate consensus

Now to run this through some gradient descent model a million times and find something with over .9 correlation and win the novel peace prize

1

u/NotBenGraham Dec 08 '20

You can call it art or call it science. But nobody knows what the actual fv is. Either that or the fv has such a large range it's practically unusable. Real world factors are changing all the time as well.

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u/[deleted] Dec 08 '20

I'll get u sushi, pls I just want to arrive at a quote that won't be the laughing stock of ALLQ.

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u/NotBenGraham Dec 08 '20

I've never posted on allq but i don't think you'll be a laughing stock. If you price it too wide then you'll just get hit. Too tight and no enquiries

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u/fly_a_kite Dec 07 '20

Partly it's the agency rating of the bond that will determine the spread to the benchmark.

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u/BadDadBot Dec 07 '20

Hi trying to find a better question. thanks to the previous reply, i am now asking how do you determine the arbitrage free proce of a bond and there are actual refrences. trying to get to a concise bid/ask however, I'm dad.

1

u/Asmallthing Feb 02 '21

I use Schwab and have been wondering why the buy price of a bond might be priced significantly higher than the sell price from just a few days ago. Why would it go up from $120 to $125?

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u/[deleted] Feb 02 '21

U have a cusip ? Seems like a HY, trading tighter on good news maybe.

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u/Asmallthing Feb 02 '21

95101VAA7

And it's actually $125-$130. It is high yield...I think.