The price at which bonds are breaking for trading in the
secondary market shows a clear downtrend year to date.
The price at which bonds are placed with initial investors is
given by the original issue discount (OID) and sets the bond's
yield to maturity. The break price, on the other hand, refers to
the price at which the bond first trades in the secondary market
after its initial placement in the primary market.
The OID is intended to give initial investors an incentive to
buy the bond in the primary market rather than waiting to buy it in
the secondary market after it's been priced. Additionally, it also
provides a small cushion in case the price declines once the bond
starts trading in the secondary market.
In bullish environments, the bonds break at a premium to
issuance, easily at 101% and approaching 102% of par. These prices
drop as the market becomes bearish and can go below par. During the
second half of 2009, several bonds broke for trading as low as 95%
of par, though several of those bonds were issued at OIDs in the
The data as of mid-June shows that the break price is in a
decreasing trend, which highlights the weakness in the market.
While just a few months ago investors would bid up the price of
bonds they could not get in the primary market, the market is now
showing less demand for new bonds once they break in the
Over the past month, there has been an increased number of bonds
issued below par, after several bullish months of issuances at par.
As the market declines, the OID will become more steep and break
prices will fall as well. As conditions deteriorate, the spread
between the OID and the break price will decrease since break price
is driven entirely by investors while OID is driven partially by
issuers, who would rather issue as close to par as possible.
The decline of the OID-break spread has been in line with the
diminished inflows into mutual fund flows. Lower inflows translate
into declining break prices as cash available for investing
The narrowing of this spread confirms the market weakness, which
translates into overall loss of momentum in the market. In the
short-term this will probably only get worse as fears of higher
interest rates heighten and investors demand for bonds drops.
While the high yield market falls, leveraged loans remains a
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