Bond Markets

In economics, a market is transparent if much is known – by many – about what products, services, or capital assets are available at what price and where.

There are two types of price transparency:

1. Knowing what price will be charged to me
   
   
2. Knowing what price will be charged to you

The two types of price transparency have different implications for differential pricing. Bond markets, unlike stock or share markets, sometimes do not have a centralized exchange or trading system. Rather, in most developed bond markets such as the United States, Japan, and Western Europe, bonds trade in decentralized, dealer-based, over-the-counter markets. This convention, combined with the large number of debt issues outstanding, is largely responsible for the lack of price transparency in the fixed-income markets.

New York Stock Exchange Most bonds are not sold in centralized marketplaces, such as the New York Stock Exchange, leading to a lack of price transparency.

Poor transparency contributes to investor differences in bond valuations and other inefficiencies that may lead to economic losses for market participants and, ultimately, inhibit business development. In such a market, market liquidity is provided by dealers and other market participants committing risk capital to trading activity.

In the bond market, when an investor buys or sells a bond, the counterpart to the trade is almost always a bank or securities firm acting as a dealer. Sometimes, when a dealer buys a bond from an investor, the dealer carries the bond "in inventory." In other words, the dealer holds it for his own account. The dealer is then subject to risks of price fluctuation. In other cases, the dealer immediately resells the bond to another investor.

Bond markets can also differ from stock markets in that, in some markets, investors sometimes do not pay brokerage commissions to dealers with whom they buy or sell bonds. Rather, the dealers earn revenue using the spread, or difference, between the price at which the dealer buys a bond from one investor–the "bid" price–and the price at which he or she sells the same bond to another investor - the "ask" or "offer" price. The bid/offer spread represents the total transaction cost of transferring a bond from one investor to another. In summary, since bonds are traded in a decentralized, over-the-counter market dominated by dealers, there is a lack of price transparency for bond markets.