New on FinoLib · Volume II: Capital Markets
I have just published a new article on FinoLib, my free finance education library: How Bonds Are Traded and How the Repo Market Works. It is part of Volume II: Capital Markets. Below is a summary of the topic in plain, expert language, so you can follow the idea even before you open the full article.
3.7 How Bonds Are Actually Traded
The idea in plain words
Stocks trade on a central exchange, but most bonds don’t. Each company has many different bonds, and each trades rarely, so dealers quote a price to buy and a price to sell and hold an inventory in between. Treasuries turn over about 3.8% of the market a day, while corporate bonds turn over only about 0.55%. So the gap between the buy and sell price, the bid-ask spread, is the main cost of trading company bonds.
Key points
■Treasuries quote in 32nds (99-16+ = 99.515625); corporates quote as a spread over a benchmark Treasury.
■FINRA’s TRACE requires dealers to report bond trades and publishes corporate trade prices.
■A 25-cent bid-ask spread on a 5-year bond costs about 5.9 bp of yield per round trip, spread over the bond’s life.
A closer look
Unlike stocks, which trade on centralized exchanges (Volume I, Part 4), the vast majority of bonds trade over-the-counter (OTC) — negotiated directly between buyers and sellers, typically through broker-dealers acting as market makers, who quote both a price they will buy at (the bid) and a price they will sell at (the ask), earning the difference (the bid-ask spread) as compensation for holding inventory risk. This decentralized structure is a major reason bond prices are generally less transparent to ordinary investors than stock prices, and why the liquidity premium in Section 3.6: Credit Spreads Decomposed exists at all.
Decision rule
Before trading a corporate bond, check its recent TRACE prints and typical trade size, and get competing quotes for anything large relative to them. Convert the round-trip cost to an annual figure: cost ÷ price ÷ the shorter of your expected holding period in years and the bond’s spread duration. Heuristic: if it exceeds a quarter of one year’s expected spread pickup, hold longer or choose a more liquid issue.
The costliest mistake
Trading illiquid bonds like stocks. Turning over the 5-year BBB bond above every month costs 12 × $25,000 = $300,000 a year on $10 million, about 3.0% of value, nearly three times the 106 bp BBB index spread on October 1, 2026. Avoid it: buy corporate bonds you are willing to hold, and adjust risk quickly with liquid benchmark issues or Treasury futures.
Recap
Bonds trade mostly over the counter through dealers because each issuer’s debt is split into many thinly traded issues; corporates turn over about 0.55% of the market a day against 3.8% for Treasuries. The bid-ask spread is the main trading cost, so convert it into yield and trade credit only as often as the spread you expect to earn can absorb.
3.8 The Repo Market — Mechanics Underneath It All
The idea in plain words
A repo is a short-term loan dressed up as a sale. A dealer sells securities today and agrees to buy them back later at a slightly higher price; that difference is the interest, called the repo rate. The securities act as collateral, like a pawn shop holding your watch. Dealers use repo to finance bond positions with little of their own money. That makes holding bonds profitable, but it leaves them exposed if prices fall, if lenders ask for a bigger safety margin, or if lenders stop rolling the loan.
Key points
■$100 million of Treasuries financed at a 2% haircut needs $2 million of equity: 50 times leverage.
■At 3.87% repo, overnight interest on $98 million is $10,535; a 26 bp yield rise erases the equity.
■SOFR, the US floating-rate benchmark, is the volume-weighted median rate on overnight Treasury repo.
Decision rule
Size a repo-financed position so equity survives a stress move and a haircut increase together: maximum face ≈ equity ÷ (DV01 per $1 of face × stress bp + haircut increase). With $2 million of equity, the note above ($0.00077 per $1 of face), a 50 bp stress and a 3-point haircut buffer: 2,000,000 ÷ (0.00077 × 50 + 0.03) ≈ $29 million, not $100 million.
The costliest mistake
Funding long bonds overnight as if the lender will always roll. The position above earns $3,849 a day of carry, but a haircut rise from 2% to 5% demands $3 million the same day, 1.5 times the dealer’s equity, and forced sales push the collateral’s price down for every holder. Avoid it: keep a cash buffer for a haircut shock and spread funding across term repo.
What the full article covers
In the full article I take you through these sections:
■3.7 How Bonds Are Actually Traded
■3.8 The Repo Market — Mechanics Underneath It All
It includes worked examples, a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, How Bonds Are Traded and How the Repo Market Works, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance