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09 23 2015 | by Victor Xing | Capital Markets

How do investors ensure best execution when trading bonds over-the-counter (OTC)?

Over-the-counter (OTC) price transparency and liquidity depends on the type of bonds

Treasury notes and bonds are highly liquid, and there are multiple platforms tracking tick by tick changes in price (and yield).  One can either look at Tradeweb or Bloomberg for real time market feeds.  There is little question on where the market is trading at the time of execution.

MBS and ABS:
There are multiple dealer platforms that stream dealer desks’ indication prices.  I used to run two dealer platforms to get a sense where things are trading.  For less liquid MBS (such as specified pools), there are semi-frequent dealer pricing updates on our Bloomberg MSG inbox, which is integrated with other Bloomberg functions such as IMGR inventory runs (you type in a CUSIP or specify criteria, and multiple dealer’s bond inventory as well as rough price indications show up).  Overtime traders develop a sense of at what levels bonds are rich / cheap based on current market conditions, which will be compared against dealer quotes with the help of aforementioned indicators.

Corporate bonds (including HY):
Things start to get tricky here.  There is Trade Reporting and Compliance Engine (TRACE), which mandates bond transactions to be posted with a 15 minutes lag.  However a lot of the corporate bonds don’t trade often, and the TRACE print may be hours out of date when one needs to execute.  Traders in the corporate sector are attuned to corporate headlines and macro risk sentiment (corporate bonds are risk assets), and they generally know whether a corporate spread level is attractive (the “corporate spread” is the difference in yield between corporate bonds and similar duration Treasuries or Swaps, which express a corporate bond’s credit risk).

Municipal bonds:
Muni is a diverse sector.  CA GO and big issuers are fairly liquid.  Not so for some of the smaller issuers such as XYZ County, New Mexico.  Since many buy side institutions simply buy at the primary market (issuance) and tuck bonds in a portfolio for the long haul, a bond may not trade for weeks, even months.  For both liquid and illiquid bonds, dealers would send us MSG indications, and traders would use IMGR or just browse through MSG

Institutional traders spend many hours looking at a predefined sector of bonds.  An experienced trader would be able to quickly determine relative value.  With a level already in mind, price / yield / spread quoted by a dealer would then appear rich or cheap.

Next article09 23 2015 | by Victor Xing | Central Banks

What are the factors that guide the Federal Reserve in adjusting monetary policy?