Does buying and selling of bonds affect market price of bonds?

Question

So I'm looking at this page:

https://www.accountingtools.com/articles/how-to-calculate-the-issue-price-of-a-bond.html

and I had a doubt.

When lots of people start buying a stock for whatever reason (irrational reason for example), the stock price goes up. Does this not happen with bonds? Because it seems the market price of the bond is fully set by pre-determined factors.

What if nobody is willing to sell the bond at the price determined by the above formula? Won't that drive the price of the bond up? Bit confused on this issue.

Answer 1

As others have noted, bonds are technically subject to the same market trading pressures as stocks, so they can do the same things.

But I want to address the point about unknown/irrational reasons for heavy buying or selling of particular bonds, and why it generally doesn't happen the same way it does for stocks. Stocks are hard to value, and much of the information that goes into valuing them is hidden, complex, or both, beyond the ability of even the most sophisticated investor to suss out. That's what allows for the wild swings in value; when everyone is investing with limited information, it's easy for misinformation and mass psychology (including "follow-the-herd" instincts kicking in to reinforce smaller movements) to influence buying behavior.

By contrast, there's really only two hidden/complex elements to valuing bonds:

1. Will bonds issued later pay better rates?
2. Is the company going to go bankrupt (and default) prior to paying off the bond?

and both of them are mitigated in ways that are essentially impossible with stocks:

1. Central banks exist to make #1 more predictable
2. Bond rating companies exist to minimize the risk of #2
3. Even in the event of bankruptcy, bond holders are paid first, stockholders second, so if the value of the outstanding bonds is less than the saleable stuff the company holds, those bonds still pay out even if the company goes under, while stockholders are left with whatever remains (nothing at all if the bondholders took a haircut themselves)

Everything else about a bond is essentially public knowledge (terms, rate, schedule, interest rates available from competing options like CDs and high-yield savings accounts, etc.), so there's nothing to use as a basis for irrational enthusiasm. For most bonds, the interest rate and payment schedule is either fixed or algorithmic in some predictable way, and it's 100% public information. You know exactly what you'll get if you buy the bond today and hold it until maturity, there's no room for "but what if the bond suddenly becomes more valuable?!?" because the only reason the bond value changes, practically speaking, is because the interest rates for newly issued bonds changed; when those interest rates go down, the value of existing (higher interest rate) bonds goes up, and vice-versa, but only in proportion to the time to maturity, and the increase in value will, as close as possible, exactly match the cost to buy a new bond with the same maturity date and payout schedule at the new interest rate.

Even if low information traders do weird things, high information traders will immediately correct for disparities, and get a reliable payout for it, because at the end of the day, they can just hold the bond until maturity to collect the real value (when value reduced by irrational trading), buy different bonds with the profits above the real value (when value increased by irrational trading), or simply avoid bonds in favor of other safe investments with better interest rates (if the auctions of new bonds are overwhelmed by morons happy to accept repayment rates well below what other safe investments provide).

In short: Stocks have many hidden and complex factors that allow speculation and irrational behaviors to occur in the absence of reliable information and the inability to develop complete expertise. Bonds don't.

Answer 2

it seems the market price of the bond is fully set by pre-determined factors.

It may seem that way by the article, but if you read closely, the price is based on a discount factor which is "based on the market interest rate", which is determined by market participants buying and selling government bonds. The coupon rate is fixed for these bonds, but the yield (discount rate) of these bonds is determined by the price that people are willing to pay for them.

For corporate bonds, there is another factor in addition to the underlying interest rate, which is the risk of default. Bond from companies that are at higher risk of default are cheaper (since buyers want to pay less for higher-risk bonds) which means that the profit (yield) is higher. The difference between the overall yield of the bond and the market interest rate is called a "credit spread". The calculation of that spread (or the risk of default) is also implied by prices that investors pay for corporate bonds, or for insurance on those bonds (credit default swaps).

All that is to say that yes, the price of bonds is definitely affected by the buying and selling of bonds, either directly or indirectly. There is no "fundamental" price for a bond other than what people will pay for it.

I would also note that the article is focused on the accounting treatment of bonds that sell for a discount or premium, and not the nuances that determine the actual market price.

Answer 3

According to this article

On the secondary market, the bond price is determined by buyers and sellers.

For example,

If a bond has a 4% coupon and the prevailing interest rate rises to 5%, the bond becomes less attractive and so its price will fall. On the other hand, if a bond has a 4% coupon and the prevailing interest rate falls to 3%, that bond becomes more attractive which pushes up its price on the secondary market.

Answer 4

If the bond is openly traded, yes, there will be a small difference between inherent value and transaction price. It does rarely go far off though, as more buyers or sellers would immediately show up if the bond gets 'cheap' or 'expensive'.

Check for example BND (https://investor.vanguard.com/etf/profile/BND), there is a 'Market Price' and a 'NAV' (net asset value), and there is a percentage that shows the current 'Premium' or 'Discount'. You can also look at this number over the years, and how it is distributed around zero.

Answer 5

The market price of bonds is determined by buying and selling, exactly like the market price of stocks.

Because it seems the market price of the bond is fully set by pre-determined factors.

Actually, the market price of bonds determines these factors. Lower market price is higher interest rate, and vice versa. (Not causes higher interest rate - it is higher interest rate)

We can expect that if there are significant differences between different bonds, some high-frequency-trading company will swoop in and cancel out the difference. For example if two bonds with very similar risk are trading at different interest rates, they would sell one and buy the other, to equalize the price and make a profit for themselves. Therefore we can talk about some factors being the same for the whole market, such as the risk-free interest rate. Other factors, like the default risk, are specific to each type of bond.

Answer 6

That depends largely on the quantity bought or sold, though how much time was taken might also matter.

When Jo Public buys or sells a few dozen - a few hundred; perhaps even a few thousand - bonds, the market takes not notice.

When Jo's broker on behalf of however many clients, buys significant numbers of (anything) the market does take notice, and some players start to follow suit.

The Question should never be "Does buying and selling of bonds affect market price of bonds"? but only ever "On what scale, or over what time does buying and selling of bonds affect the market price"?