Bond Trading Process
For those new to the fixed income market, and even for long-time bond investors, bond trading can be a bit nebulous. In many ways, trading bonds is the same as trading stocks or mutual funds. There are, however, a number of details related to fixed income assets that make bond trading processes unique.
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Basic Trade Vocabulary
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All bond trades share a common vocabulary. "Trade date" is the day a buyer and seller enter into a purchase agreement. "Settlement date" is the date when money will be exchanged for shares. "Face value" is the dollar amount on which the interest will be paid. "Principal" is the actual initial investment to buy the bond. It may be equal to face value, or it may be adjusted up or down based on external market forces. Most bonds trade "OTC," or over the counter, meaning that they trade through securities firms rather than a stock exchange.
Trade Procedure
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Once you select a bond through your investment representative or online through a broker, you place a trade. The date you place the trade becomes the trade date, and determines the settlement date. Most corporate bonds settle three days after trade date, known as T+3. U.S. Treasury bonds settle the day after trade, (T+1), while asset-backed bonds like Fannie Mae may settle several days later. On settlement date, your broker will wire money to the seller on your behalf and you will receive shares of the bond in return.
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Primary and Secondary Market
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Bonds are sold on the primary market and the secondary market. A primary market bond is a new bond; you buy directly from the issuer and the trade settles on the first date the bond is available, meaning that you may have several weeks between the trade date and settlement date. Secondary market bonds are purchased from other consumers who have owned the bonds for a period of time.
Interest Payments
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Bonds accrue interest on a daily basis and pay that interest periodically throughout the year -- usually semi-annually. These payments are made to whoever owned the bond on the payment date, whether or not he held it for the entire period. If you purchase a bond between interest payments, you will pay the seller the value of the accrued interest as part of the trade. This amount is paid back to you when you receive the full interest payment later in the year.
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