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Why Is There a Stock Exchange But No Bond Exchange?

Why Is There a Stock Exchange But No Bond Exchange?
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It can be surprisingly difficult to match buyers and sellers of bonds. Kathy Jones, Schwab’s fixed income strategist, explains why.

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Rick Karr:
You can see the family resemblance in stocks and bonds. They’re almost like siblings. They share a lot of history and grew up together. They have shared ancestors, and people are constantly comparing them to each other. There are big differences. One’s a loan that’s ultimately paid off, and the other is a way of owning part of something indefinitely. But more broadly, they’re both ways of financing things and they’re both bought and sold by investors. 
Stocks go through exchanges: NASDAQ, the New York Exchange, London, Shanghai and 50 or so others around the world. But there’s no New York Bond Exchange or Frankfurter Unternehmensanleihen Börse. We wondered why there isn’t and what bonds might have instead. 
You’re listening to the Insights & Ideas podcast brought to you by Charles Schwab. I’m Rick Karr. When we have questions about the bond market, we turn to Kathy Jones. She analyzes the bond market and everything related to it for Charles Schwab. The first thing she told us when we asked her why there’s no bond exchange is that some bonds are traded on exchanges like the NYSE. They can also be bought and sold on some virtual markets that operate like exchanges.
Kathy Jones:
These are basically computer networks where bonds can be bought and sold. They’re not registered exchanges however. What we do at Schwab is we aggregate many of these networks so that we can offer clients a central place to buy and sell. But they’re relatively new and not all bond sales take place on them. There’s still a portion of the bond market that’s traded on a negotiated basis. In other words, with buyers and sellers on the phone. In that way, it’s still the old-fashioned way that it’s been for quite some time.
Rick Karr:
So that sounds more like, “I’m looking for something in an antique store, and I have to go antique store to antique store to see who has it?” Rather than going to a big retailer who I know is going to have what I want.
Kathy Jones:
Yeah, it’s an old-fashioned system and it has its problems. There can be many prices for a bond. So if you search for a bond by calling many different dealers, it might take some time to find the best price. And if the market’s moving, then you can’t be sure that the first price you’ll find will still be available when you get back around to calling that person who offered it to you. And it can push prices higher.
So if a bond is passed through many dealers before you get it—let’s say there’s a very specific bond that you want—and it’s hard to find someone to sell it. Every dealer who has it might want to get a little profit on it and mark up the price. So by the time you get it, it could be a bit more expensive. So the old system, the negotiated system, has its issues, which is why we’re kind of moving toward these automated trading systems. But it’s still a market very much in transition.
Rick Karr:
So stocks have been traded on exchanges since the late-18th century. Is there a particular reason why the bond market never adopted that model?
Kathy Jones:
Yeah, there are a couple of good reasons. One is there are a lot of bonds. So you think about a typical company that issues maybe one or maybe two kinds of stock, that same company might issue hundreds of different kinds of bonds. They might have different maturities, different features, different credit profiles. Some could be issued by subsidiaries of the company. So there are so many bonds—a bond is not a uniform almost commoditized product that’s easily bought and sold. 
Governments do the same thing. Governments issue many maturities of bonds, different types of bonds. And this is because they need to borrow money at all times, and roll over some of their debt at different times. They want to pay it back at different times in the future. So it really depends on what’s being done with the money. So every bond has some unique features to it. And that means it isn’t as easy to just transact in one or two bonds the way you would with one or two issues of stock for a company, say.
Rick Karr:
So it sounds like companies are like individuals. We have car loans, credit cards, mortgages—and they have different kinds of debt, too. 
Kathy Jones:
Absolutely. Say they’re borrowing money one year because they’re financing a new plant that they’re building, to build some machinery. That financing would be very separate from the financing, say, of their inventories or of a seasonal product that they’re producing where they expect to get the revenue six months from now, but they have to finance six months ahead.
You think about a company like GE. It issues one stock. But it has hundreds of different GE bonds out there—and for various different reasons, for again, various subsidiaries that they might have. So you multiply that by the hundreds of companies and governments that issue bonds. There are just simply too many for an exchange to keep track of.
Rick Karr:
And in terms of dollar volume, the bond market kind of dwarfs the stock market. 
Kathy Jones:
The bond market is many times larger than the stock market. Again, you’re talking about companies, governments, institutions financing projects over many years, long periods of time, so often that requires a substantial amount of financing to take place, but they don’t all trade on the secondary market and they don’t all trade frequently.
So you consider, let’s take a municipality—the City of New York issues bonds all the time. But a lot of the buyers of those bonds will simply buy them and hold them because they get the tax-exempt income, and they’re buying them for the income stream so they don’t really have an interest in selling those bonds prior to maturity. It’s part of the income that they’re earning.
Same with an institution, a pension fund, you know, they have obligations running many years into the future. So a lot of times they’ll buy bonds, long-term bonds and just hold them because they’re using the income earned on the bonds to pay out to, say, the pensioners to whom they owe money on a regular basis. So again, they’re not likely to trade those bonds very often.
Rick Karr:
You seem to be having fun. You know, you like your job I can sense. What is it about bonds that got you?
Kathy Jones:
You really have to put all the pieces together. There are lots of moving parts when it comes to the bond market. There are the macroeconomic drivers for what drives bond prices in general. So I like to know how all those pieces fit together. Then there’s the individual bond and its structure, its maturity, whether it’s callable. I like numbers, so I like the ability to look at the probabilities that go with it. 
There’s a lot of variety there and it’s a fascinating topic. I think bonds are wonderful. They’re about the most interesting security out there.
Rick Karr:
So when a company has hundreds of bonds out there, does every one of those bonds tell us something a little bit different to form a bigger picture?
Kathy Jones:
Absolutely. So if you look at a company that has a lot of bonds outstanding, what you’ll see is, you get a sense of how they’re financing their business, where they’re putting their money in the business, how well perhaps they’re doing in that business. The bond market often tends to lead other sectors of the markets in signaling problems or progress for a company. 
For instance, a lot of times what we’ll see with a bond is that a company’s bond price will move before its stock price moves when something’s happening. So that’s kind of a signal that we can watch. But it is important to know how much leverage does a company have on its balance sheet? 
And you only find that out through looking at the bond holding set, the bond issuance that they’ve done and how much borrowing they’ve done—when it’s due, what the timing of those payments are, what the costs of those payments will be and how much financing they plan to do in the future—is often linked into their profitability. So you get a good window into a company when you look at their bonds.
Rick Karr:
I was talking to your colleague Liz Ann Sonders recently, and I was a little bit surprised to learn that the stock market tends to lead economic indicators. So it sounds like what you’re saying is the bond market is the leading leading indicator in some ways.
Kathy Jones:
Well, it is interesting. So one of the current things that’s happening is we’re seeing what we call credit spreads widen. That is, the yield on corporate bonds is moving up faster than the yield on Treasury bonds. So that difference is called the credit spread. And that really indicates how difficult or easy conditions are for companies to borrow money.
And when we see the corporate bond spreads widening—that is, the cost of money to corporations going up faster than the basic level of interest rates—what it tells us is that financing is getting more expensive. And that means the lenders are getting more nervous and they want more compensation for the risk of lending money. And that’s often a leading indicator of what’s going on in the economy and what’s going on in the corporate world.
Rick Karr:
Isn’t that just an acknowledgment though that the Fed has been expected to raise rates? 
Kathy Jones:
Well, if it’s just about the Fed, then Treasury yields would be going up as well, so the spread might not change. But what we’re seeing is when rates have pushed higher, we’re seeing the rates for a company push higher than for the Fed. So it actually tends to work in the opposite direction when the economy is growing at a robust level and profits are growing and it’s a rosy outlook, those credit spreads actually tend to narrow. 
Right now they’re tending to actually widen a bit, which just indicates more caution on the part of lenders.
Rick Karr:
Kathy Jones, it is always great to have you on Insights & Ideas. Thanks for coming in.
Kathy Jones:
Thank you.
Rick Karr:
Kathy Jones is a senior vice president and the fixed income strategist for Charles Schwab. If you want to follow her on Twitter, her handle is kathyjones all one word, Kathy spelled with a K. K-A-T-H-Y-J-O-N-E-S. That is it for this installment of the Insights & Ideas podcast brought to you by Charles Schwab. You can find us on iTunes or go to insights.schwab.com. Our producer is Matthew Nelson. I’m Rick Karr. Thank you for listening.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. 

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

All bonds and market data mentioned are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

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