FI 3 Fixed-Income Issuance and Trading

Bonds and the markets that trade them are sorted along three main dimensions: the type of issuer (often called the sector), the credit quality of that issuer, and the time left until the bond matures. Analysts sometimes attach further tags, such as the currency of the bond, the region the issuer calls home, and its environmental, social, and governance (ESG) profile. A defining contrast with equity is sheer count. A company usually keeps one or two share classes, yet the same company can carry dozens of distinct debt instruments at once. At the close of 2021, for instance, Apple Inc. had a single class of common stock outstanding alongside more than 80 separate fixed-income instruments.

The reason for so many is that a borrower mixes tools to fund different needs. A corporate may run bank loans, bonds, or both, some maturing in months to cover working capital and others stretching for years to fund plant and equipment. Large firms often add commercial paper, a short-dated instrument used for working capital that can be backed by specific assets, and they may borrow in several currencies to hedge exposures and reach a wider set of lenders.

The credit and maturity map

Instrument types settle into recognisable places on a grid of credit quality against maturity. Sovereign issuers in a developed market are usually the safest borrowers, so their bills, notes, and bonds occupy the top band, treated as default risk free, across every maturity. Investment-grade names fill the middle, from commercial paper and repurchase agreements (repo) at the short end out to corporate bonds, asset-backed securities (ABS), and mortgage-backed securities (MBS) at longer tenors. High-yield borrowers sit in the lower band and reach the market mainly through secured corporate bonds, asset-backed commercial paper (ABCP), and leveraged loans.

Investors line up against the same map. Buyers take positions that suit the risks they want and the obligations they must fund. Someone who needs cash soon, or wants a liquid place to park it, leans on money market securities; someone funding a distant obligation, or reaching for extra return, accepts more interest rate risk with long bonds. Pension funds and insurers, whose liabilities stretch far into the future, favour bonds with fixed periodic coupons and maturities that line up with those liabilities. Credit risk can be layered on at any maturity to lift returns.

Credit ratings

A widely used gauge of credit quality is the credit rating: a letter-grade opinion, issued by a rating agency, of how likely an issuer is to meet its obligations. It blends the chance of default with the loss expected if a default happens. Ratings apply to short-dated and long-dated debt alike, and they attach both to an issuer and to each of its individual issues. Standard and Poor’s (S&P) and Moody’s are two of the largest agencies. Many funds cap how much unrated paper they may hold.

Category based on S&P Global Ratings. Descriptions summarised.

The dividing line matters. An issuer rated BBB- (Baa3 on the Moody’s scale) or higher counts as investment grade; an issuer rated BB+ (Ba1 on the Moody’s scale) or lower is called high yield, speculative grade, or junk. The high-yield ranks include fresh issuers whose cash flows are not yet steady, so lenders often demand collateral, plus former investment-grade names whose quality has slipped since issuance, nicknamed fallen angels.

Developed-market sovereigns, able to tax their economies, usually hold the top rating in their market and anchor the default-risk-free band. Their bonds are widely held by foreign investors and by foreign central banks that want reserves in the market’s currency held as an interest-bearing asset, and central banks lend or borrow these securities to raise or lower monetary reserves. Because defaults are rare among investment-grade names, their expected returns run below high-yield returns and roughly level with, or a little above, sovereign returns. High-yield buyers demand more for shouldering a higher default chance and often measure their results against equities.

Just as equity indexes summarise the risk and return of stock markets, fixed-income indexes track bond markets. They let investors judge how a market has performed, benchmark investments and the managers who run them, and build index-tracking strategies. Three features set bond indexes apart from their equity cousins.

1. One issuer, many bonds. A single borrower can have numerous eligible bonds, and every qualifying bond enters the index, so bond indexes carry far more constituents than equity indexes do. Some hold more than 10,000.
2. Heavy turnover. Bonds mature and new ones arrive constantly, so the membership changes far more often than in an equity index. A bond index is typically rebalanced monthly, admitting new issues and dropping any that have slipped below a minimum remaining maturity.
3. Value weighting. Where equity indexes often weight by market capitalisation, bond indexes usually weight by the market value of debt outstanding. Because governments issue so heavily, broad bond indexes tend to carry large government weights, and their makeup drifts over time with the balance of public versus private issuance, lengthening maturities, and any change in credit quality.

Because a full bond index is too complex to buy outright, a fund tracking one normally holds a representative sample of its constituents to reproduce the return rather than owning every bond. Indexes themselves range from aggregate benchmarks with a vast constituent list to narrower ones built around a single sector, credit band, maturity range, geography, or ESG screen. The right benchmark for judging a manager should mirror that manager’s strategy in both maturity and credit quality.

Ratings shown as Moody’s / S&P / Fitch where three are given.

The Bloomberg Barclays Global Aggregate Index gathers fixed-coupon capital-market securities from every major type of issuer across 28 developed and emerging markets, but it leaves out high-yield paper, unrated paper, and issues below the minimum size. A fund tracking it gains broad exposure with turnover limited to new issuance or removals, and hedged and unhedged variants let an investor either absorb or neutralise currency swings using forwards on rebalancing dates.

The J.P. Morgan Emerging Markets Bond Index Plus (EMBI+) is far narrower: US dollar sovereign debt of emerging markets at or below a set credit quality, sized at USD 500 million or more, aiming for a higher dollar return than developed-market sovereigns in exchange for taking on the external debt risk of the issuer countries. The Bloomberg Barclays MSCI Euro Corporate Sustainable SRI Index filters by sector, currency, credit, and maturity, then adds ESG screens: it insists on an MSCI ESG rating of at least BBB, then shuts out issuers active in lines such as alcohol, tobacco, gambling, adult entertainment, nuclear power, firearms and military weapons, thermal coal, and oil sands, as well as any issuer carrying a red MSCI Controversies score.

A primary bond market is where an issuer sells brand-new bonds to raise money. Secondary markets, covered in the next section, are where investors trade bonds that already exist. A borrower coming to the bond market for the first time, a debut issuer, gives investors their first chance to buy its bonds, much as an initial public offering does for shares. Bonds can go out through a public offering, open to any buyer, or through a private placement, open only to a chosen investor or a small group. Like a first equity sale, a debut bond issue often swaps private debt, such as a bank loan, for publicly traded bonds.

Typical debut issuers include:

• new legal entities created by a merger, acquisition, or divestiture, which usually refinance all of their existing debt;
• companies that mature into a steadier-cash-flow stage of the life cycle and start to issue debt; and
• sovereign governments raising foreign-currency debt abroad for the first time.

For a debut name that must clear a domestic or Eurobond registration, the underwriters usually run roadshows and briefings over several weeks beforehand, so potential investors get to know the new entity and understand how it will repay.

Repeat issuers and the underwritten deal

For an established issuer the process is far quicker than for a debut name, and quicker even than a follow-on equity sale. A public company returning to the equity market simply sells more of the identical share, whereas a bond issuer normally brings a fresh security priced at or near par. Less often, it enlarges an existing bond at a price well away from par, a step known as a reopening. For unsecured investment-grade corporates, the whole sale can run within a few hours.

The timeline above describes an underwritten offering, where one or several financial intermediaries (the underwriters) guarantee the sale of the issue at a price negotiated with the issuer. Investors in these frequent-issuer bonds usually know the indenture and financial statements well, and the issuer, like BRWA, times the deal opportunistically when conditions look best. Underwriters steer the order book toward large institutional buyers at the tightest spread they can achieve across maturities. Frequent issuers rely on a shelf registration, a standing offering document that is refreshed regularly and reused for a range of future issues.

Best-efforts, private placement, and auctions

Secured deals from high-yield corporates, some special purpose entities, and similar issuers (VIVU among them) usually take longer and demand more work, because investors must digest complex covenants and weigh operating cash flows together with collateral as the sources of repayment. For a weaker credit, the intermediary may decline to guarantee the sale at all and instead serve merely as a broker on a best-efforts basis, selling on commission at the agreed price wherever it can. Where the deal is small, the issuer is little known, or the terms are highly customised, the bond may take the form of a private placement: an unregistered, non-underwritten sale to a small group of investors. Sovereign primary issuance usually runs as a public auction managed by the national treasury or finance ministry, a mechanism covered in a later module.

Once issued, bonds change hands in the secondary market. Despite steady growth in electronic platforms such as MarketAxess and Tradeweb, bond trading remains largely quote-driven, that is over-the-counter (OTC), instead of exchange-based. The main participants are institutional investors (the Baywhite funds among them), financial intermediaries, and central banks. This is a sharp contrast with listed equities, whose secondary trading happens largely on electronic exchanges.

Liquidity and the bid-offer spread

Liquidity differs widely across segments, and even among the bonds of a single issuer. The key liquidity measure is the bid-offer spread: the gap between the price at which a dealer will buy from a customer (the bid) and the price at which it will sell to a customer (the offer). In bond markets this spread is usually quoted in basis points.

On-the-run bonds, meaning the most recently issued developed-market sovereigns, are usually the most liquid securities anywhere: primary dealers quote active two-way markets in large size at spreads of only a fraction of a basis point, and a few markets, Australia among them, even list their sovereigns on an exchange. Recently issued bonds from frequent, higher-quality corporate issuers come next, since dealers tend to hold trading inventory in fresh issues and can quote a few basis points. Bonds of infrequent issuers, or seasoned bonds from frequent ones, rarely change hands, so dealers post at least 10 to 20 basis points, or wider, on small trades.

One event can revive trading in an otherwise quiet seasoned bond: a sharp deterioration in the issuer’s credit quality.