In general corporate treasurers tend not to be active buyers or sellers of bonds in the secondary market, however they do have a strong interest in the secondary market on account of their involvement in the primary markets. Major corporates will use the US, UK and Euro bond markets for launching new issues of bonds as part of their capital raising activities. For a corporate new issue the price and yield at which they can successfully launch their company’s bond issue will be one of the prime elements for consideration. The yield at launch will be based on the secondary trading levels of their existing bonds or of near comparable credits and adjusted for other factors such as maturity, amount of issue, any special terms and conditions and the general state of the markets. CDS (Credit Default Swap) markets are also a pricing reference point as stated later in this paper.
However the secondary corporate bond markets and to a lesser extent the CDS markets are inherently illiquid. For many bond issues where the entire issue size amounts to only a few hundreds of millions the volume of secondary trading is bound to be small or negligible. Secondary market bond pricing is therefore not a perfect indicator of new issue pricing.
However, since the new issue market is to an extent dependent on the health of the secondary market there can be several aspects of the secondary market the corporate treasurer will nonetheless take an interest in:
Liquidity: A buyer of a new issue, even if they plan to buy and hold, will take comfort from the ability to trade a bond if need be and therefore an adequate degree of liquidity is desirable. While true liquidity is unlikely, the issuer and investors will expect the original lead managers to be prepared to quote a price.
Accuracy of pricing: The issuer will want to ensure that the price and yield with which it comes to market are a fair representation of the ‘correct’ level that matches its reputation and credit rating.
Traditionally, the pricing of a new issue has been rather more an art than an exact science, although it is worth considering whether this has been because of some market deficiencies. Currently most issues are launched with an indicative spread over the swap rate or government benchmark. The issuer and his syndicate of banks determine this from the secondary bond market and from the credit derivative market where credit default swaps (CDS) are traded on a similar basis by reference to a credit spread.
Theoretically one might expect the bond spread and CDS spread to be very similar but there can be technical reasons why they diverge. The lead managers will then build an order book based on the indicative spreads and by closing will be able to judge the ‘right’ launch spread.
Corporates will tend not to be directly involved in the secondary bond markets. However certain issuers may be active purchasers of their own debt in the secondary market when they have a specific reason to retire debt, eg to remove certain covenant restrictions, or when they wish to adjust their maturity profile or take advantage of other refinancing opportunities. The fact that arbitrage type opportunities can sometimes exist may indicate a deficient market pricing or it may be caused by a justifiable factor such as investors seeking to sell out of an old illiquid issue and reinvest in a larger more liquid new bond.
