Bonds 10 – How do you actually buy a bond, in practice?

Susan
By Susan August 6, 2012 08:46

Bonds 10 – How do you actually buy a bond, in practice?

 

And now comes the moment of truth – completing your first bond trade!

 

Of course this is rather theoretical, since you will first have to decide that bonds are what you need in your portfolio, and exactly what bonds are a good fit for your strategy. These are questions only you can answer.

 

On the other hand, the practicalities of investing in bonds apply to everyone. A bond trade is a bond trade, whatever your investing strategy is.

 

And in my experience, practical, nitty-gritty questions also hold people back, as much as, if not more than, really tough questions of “What proportion of bonds do I want in my portfolio? And which bonds do I buy?”

 

Indeed, there is something definitive about a trade that makes people nervous. To make sure that it’s not the little details that hold you back, here it is – how you buy a bond, in practice!

 

 

Buying a bond, step by step

 

Personally I have always bought and sold bonds over the phone, so this is what I will be referring to here. Also, you will need to have a funded trading account.

 

First of all, you will need to know the ISIN of the bond you want to buy, as the broker is not going to supply it. The ISIN insures that you know exactly which bond you are buying. The ISIN is the bond code, or “International Securities Identification Number” and you will find it on investinginbondseurope.org, or investinginbonds.org if you are buying Treasury (US) bonds.

 

Indeed, there would be no point in calling a broker and asking to buy “a German ten-year bond”, as there are several bonds with that maturity, but with very different characteristics!

 

Then, you will tell the broker whether you want to buy or sell, and what quantity (the amount of money that you want to invest, if you are buying). The broker will do the quantity calculation for you and tell you how many bonds that represents.

 

You will then tell the broker whether you want to place a market or a limit order (more on this below), and if it is a limit order, what price you want to buy at. The broker will quote you an ask price and a bid price (you buy at the ask price and sell at the bid price).

 

The more liquid the bond, the quicker the trade will take place: the broker might ask you to hold the line a few minutes; if it is a market order (and the market is open of course), they will then confirm the trade, and the price at which the trade took place. For less liquid bonds, the broker might have to ask around and call several market makers for a quote: this might take a few hours.

 

You will then get an email confirming the trade, and you will have to allow for a few days for the trade to settle, that is, for the money to leave your account and the chosen security to get into your account. You can then monitor the price of the bonds you own on a daily basis, when you log on to your trading account.

 

 

And when you want to sell your bonds?

 

It is the exact same transaction, only you will tell the broker you want to sell, instead of buy, and you will quote, not the amount you want to sell, but the number of securities. Just like when buying, you will need to quote the ISIN, and you will have to decide whether to place a market or a limit order.

 

You might want to sell your “full holding” (all the bonds you own that are of a certain type), or only a certain number. Make sure you check in advance how many securities you own, and how many you want to sell: I find that people often know the price they bought at and know how much of a security they own (the total amount of money), but rarely do they know the actual number of securities that they hold. Why would they – this number doesn’t matter, but the other two do!

 

So check that and save yourself the awkward moment on the phone when the broker says “So how many do you want to sell?” and you say “Actually, I’m not sure, let me check”…

 

 

What is it with market or limit order?

 

When placing a trade, you have to specify to the broker whether you want to buy or sell now at the market rate, or whether you want to buy or sell when the security reaches a specific price.

 

If you place a market order, the price will be the best price that the market maker can give the broker at that time: under European legislation, the broker must give you “best execution”.

 

To place a limit order on the other hand, you specify the price at which the broker should carry out the trade for you. Say the bond you have set your sights on has an ask price of 102. You place a limit order to buy at 99. This means the trade will only take place when and if that bond reaches an ask price of 99.

 

Depending on your instructions, the broker will hold that order for one day, or your limit order will be “GTC”: “good till cancelled”. In practice, a limit order is automatically cancelled after a certain time, usually 30 days; unless of course you cancel it yourself before it expires.

 

Placing a limit order involves two risks: first, if the security you want never reaches the price you want, you will have to cancel the limit order and go back and get the security at the market price. If you’re buying and the ask price has risen in the meantime, or if you’re selling and the bid price has fallen, that’s too bad…

 

Secondly, if the price of the security changes, but doesn’t pass through the exact price you specified, the trade won’t take place. If the bond you wanted to buy at 99 goes from 102, to 100.9, directly to 98.9, your order will not be carried out because the bond price didn’t pass through 99.

 

This is also valid of course when placing a limit order to sell.

 

 

In a nutshell

 

So, to recap, this is what a bond trade looks like:

 

  • Call your broker
  • Quote the ISIN of the bond you want
  • Specify whether you are buying or selling
  • Specify the quantity (amount of money when buying, number of bonds when selling)
  • Specify whether this is a market or a limit order, and what your limit price is.

 

The costs vary from broker to broker. Because you’re doing this over the phone it costs more than online trading, but generally charges represent around half to three quarters of a percent.

 

Remember also that bonds are traded in round lots, that is, you cannot choose the number of bonds you want to buy, but will have to settle on a number of “bundles”. A round lot could represent for example €1000 or $1000 of face value. If the bond is trading at half its face value (a bit of a stretch, but it might happen – Irish government bonds were nearly there last year), you will be spending €500 plus the costs on the trade when buying.

 

 

And… And that is all?!

 

Yes. Welcome to the “mysterious” world of financial markets. There isn’t much of a mystery. With “just a couple” of differences, it is, after all, quite similar to walking into the corner shop and asking to buy a pound of oranges

 

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Susan
By Susan August 6, 2012 08:46