Bid/offer spreads

The expectations of market players and eventual outcomes in relation to micro level allocation plans for the second phase will have considerable impact on the functioning of the market for CO2 allowances and therefore the success or failure of the scheme. The updating of allocation plans required by the Directive takes away an underlying assumption of most economic assessments of emission trading schemes, i.e. that distribution does not affect efficiency unless transaction costs are high. Updated allocation plans have the effect of altering the abatement and production choices made by participants. Where participants believe that the base years in future allocation plans will be updated there is an incentive to increase emissions. The uncertainty as to whether or not this will happen in the second NAPs is likely to result in increased volatility and illiquidity (wider bid-offer spreads)... 

The relative liquidity of the Eurobond market compared to the United States is a hotly debated question. The general impression is that the Eurobond market is less liquid than the US corporate sector. The average transaction size is greater in the United States, reflecting the market s larger size ( 1,679 billion versus 651 billion) and the concentrated structure of the investor base. Other obvious liquidity metrics, such as bid/offer spreads are hard to track consistently. What is true is that secondary market trading conventions have converged over time. 

The maximum bid/offer spread is adjusted according to the remaining life of the bond. 

Like Pfandbriefe, Obligations Foncieres bondholders retain preferential rights with regard to the event of bankruptcy over any other claims. The similarities do not stop there. Issuers and market makers have agreed that the minimum size of issuance should be 500 million, that the issue is supported by a market making commitment from at least three banks, quoting continuous prices with bid/offer spreads of between 5 and 20... 

The offer price that the dealer would quote the fixed-rate payer would be to pay 8.85% and receive EURIBOR flat. (The word flat means with no spread.) The bid price that the dealer would quote the floating-rate payer would be to pay EURIBOR flat and receive 8.75%. The bid-offer spread is 10 basis points. 

A much easier method of generating leverage in a credit portfolio is through credit default swaps (CDS). They let investors take on or lay off default risk in an unfunded manner. Selling default protection enables one to receive the premium associated with the additional credit risk without the need to buy a bond of that entity, and in the process creates enormous leverage, especially for higher rated credits. The increased liquidity and the compression of bid/offer spreads have added to the attractiveness of this market. 

Transaction costs Certain indices ignore bid-offer spreads, which means that bonds get in and out of the index at the same price. Bid-offer spreads and other transaction costs, which affect real portfolios, can cause an index that ignores these to outperform by a significant amount. 

In this example, the bank is quoting an offer rate of 5-25 percent, which is what the fixed-rate payer will pay, and a bid rate of 5-19 percent, which is what the floating-rate payer will receive. The bid-offer spread is therefore 6 basis points. The fixed rate is always set at a spread over the government bond yield curve and is often quoted that way. Say the 5-year Treasury is trading at a yield of 4.88 percent. The 5-year swap bid and offer rates in the example are 31 basis points and 37 basis points, respectively, above this yield, and the bank s swap trader could quote the swap rates as a swap spread 37-31. This means that the bank would be willing to enter into a swap in which it paid 31 basis points above the benchmark yield and received LIBOR or one in which it received 37 basis points above the yield curve and paid LIBOR. 

The fair price of a convertible bond is the one that provides no opportunity for arbitrage profit that is, it precludes a trading strategy of running simultaneous but opposite positions in the convertible and the underlying equity in order to realize a profit. Under this approach we consider now an application of the binomial model to value a convertible security. Following the usual conditions of an option pricing model such as Black-Scholes (1973) or Cox-Ross-Rubinstein (1979), we assume no dividend payments, no transaction costs, a risk-free interest rate, and no bid-offer spreads. 

To establish a framework for supply chain intermediary analysis, we focus on the economic incentives of three types of players suppliers, buyers, and intermediaries. All players are self interested, profit seeking, and risk neutral. In the simplest form, each supplier has an opportunity cost s, each buyer has a willingness to pay level v that could be public or private information depending on the model assumptions. The intermediary offers an asked price w to the supplier and a bid price p to the buyer while creating a non-negative bid-ask spread p — w) to support her operation. The intermediary has the authority to determine whether a particular trade is to take place using control p. Adopting some mechanism T P,p, w), the intermediary optimizes her own profit. 

The intermediary s profit is generated from the bid-ask spread after taking out the transaction cost, i.e., p — w — K) = T — K. Thus, the intermediary can only extract profit if she could offer a more efficient transaction with K [Pg.79]

Moreover, under Bertrand price competition, the market price will equal to marginal cost and the intermediary will earn zero profit. Thus, she must offer a bid-ask spread no more than... 

The bid or offer from a dealer (depending on whether the customer wants to sell or buy bonds) is usually in competition with at least one other intermediary. The transaction is done on a price basis. This is usually straightforward. Disputes around prices are rare, since the spread is agreed, the price of the underlying government security is known from marketwide information screens, and the price calculation method is a matter of market practice. 

The fixed rate is some spread above the benchmark yield curve with the same term to maturity as the swap. In our illustration, suppose that the 10-year benchmark yield is 8.35%. Then the offer price that the dealer would quote to the fixed-rate payer is the 10-year benchmark rate plus 50 basis points versus receiving EURIBOR flat. For the floating-rate payer, the bid price quoted would be EURIBOR flat versus the 10-year benchmark rate plus 40 basis points. The dealer would quote such a swap as 40-50, meaning that the dealer is willing to enter into a swap to receive EURIBOR and pay a fixed rate equal to the 10-year benchmark rate plus 40 basis points and it would be willing to enter into a swap to pay EURIBOR and receive a fixed rate equal to the 10-year benchmark rate plus 50 basis points. 

A bank s swap screen on Bloomberg or Reuters might look something like FIGURE 7.3. The first column represents the length of the swap agreement, the next two are its offer and bid quotes for each maturity, and the last is the current bid spread over the government benchmark bond. 

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