Illiquid bonds

According to Merrill Lynch (ML) indices, that is, without illiquid bonds (outstanding below 1 billion) or bonds shorter than a 1-year maturity. 

Liquidity premium The effect of liquidity premium is more pronounced in indices that have lower thresholds and by extension contain a larger number of illiquid bonds. As discussed earlier, as illiquid bonds have higher yields, and render a natural advantage to the index, as investors are unable to buy them at prices they are quoted in the index. 

Liquidity demand The CDS for a cash bond may reflect a liquidity premium for that name. Therefore for illiquidity issue the protectimi requires a premium, increasing the CDS basis over the ASW spread. Note, the CDS price will be influenced also from the liquidity embedded in the synthetic instrument, which may be more or less liquid. 

Inflation-linked bonds are a little less liquid than nominal bonds, but the possibility that this results in them trading cheaply—suffering an illiquidity discount —is contentious. We would propose that turnover is lower in linkers because they meet investor needs so well. They are natural buy-and-hold assets because they are worry-free core holdings. Thus, illiquidity, relative to nominals, is something investors in linkers understand and accept. It is not so much a penalty, more the price of success. 

The other thing that is important to know about savings bonds is that you cannot sell them in a secondary market they are considered to be an illiquid investment. If you redeem them early, you or the beneficiary will pay severe penalties, forfeiting a substantial amount of interest. 

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