Offerings
Situation trading. The job description of a municipal bond trader differs from one company to the next; however two requirements appear to be universal. The first requirement is that the trader is charged with maintaining appropriate inventory positions for his/her sales staff to sell to the firm's retail and institutional customers. The second requisite of this position is that the trader exhibits a thorough command of his/her market and/or territory, a command that translates into trading account profitability for the firm. The goal of the trading department is to turn over its inventory quickly and profitably. Carrying inventory for an extended period of time is expensive because it ties up capital that could be used elsewhere within the firm. Dealers usually borrow to finance their securities inventory, whereas dealer banks are funded internally. The cost of funds for a dealer bank is calculated based on what the bank could make if they invested the funds through their Money Desk or in their Portfolio, resulting typically in a soft dollar charge to the trading department. Moreover, holding inventory carries with it an inherent risk of loss should interest rates move up quickly, as prices must then be marked down.
When a trader purchases a "block" (generally 250m or more) of bonds they generally mark the position up and "show the bonds internally" (offer them solely to their sales force) for a period of time. The "offering" (bond position that is owned and offered at a specific price; the price the trader would like to obtain when selling the position) will be shown to the street at the trader's discretion, usually when his sales force has either shown no interest in marketing the bonds or has been unable to elicit interest from their client base. If the position was purchased originally from a broker's broker, the correct protocol is to make the street offering first to the broker who sold you the bonds. Customarily, the broker's broker is given a 30-minute head-start on his/her competition. Following the head-start time period, the dealer offers the bonds street wide through additional broker's brokers and online services; the more dealers who see the offering, the more likely the bonds are to trade.
Broker's brokers receive "offering runs" (lists of bond positions owned and offered by dealers and dealer banks) that are updated daily by the owner of the bonds, aggregated by the broker's brokers and distributed to the dealer community nationwide. An experienced broker's broker will see value between like offerings, identify the bonds they feel should trade next due to quality/pricing/market factors and call dealers/banks that they know will be interested in "picking up" (purchasing) an attractive offering.
When the broker elicits interest from a potential buyer the bidder "shows a bid" (indicates the price they will pay to purchase the bonds, almost always lower than the listed or offered price) to the broker. In the situational sector of the secondary market a bid on an offering is understood to be good for only a few minutes. The broker's broker then calls the owner of the bonds to "reflect the bid" (inform him of the price the buyer wishes to pay to purchase the bonds). At this point the dealer has many options:
- 1.) The dealer may "hit the bid" (sell his bonds to the bidding dealer). The only question left in this instance is who will pay the broker's brokers commission? As with everything else in the situational market, this is a point of negotiation. One or both dealers/banks agree to pay the broker's broker and the transaction is executed. If no one is willing to pay the broker's commission, the bonds will not trade into the bid.
- 2.) The dealer may reject the bid by either "besting" (telling the broker that his offering price is the "best" or cheapest that he will trade his bonds) the broker's broker or by choosing to not "make a counter" (counter-offer to the potential buyer; less than the original offering, but not as cheap as the buyer's bid). If 'best-ed'or not countered, the broker's broker will ask if the owner "repeats the offering" (indicating to the potential buyer that the price is the price: love it or leave it) or whether they perhaps "get them out there" (sell the position at the offering price, but agree to pay the broker's broker commission on the transaction-which is a concession in this type of transaction, indicating an acknowledgment for the work the broker's broker is doing on behalf of the dealer who owns the bond position). The response is relayed to the dealer that bid the bonds, with the process involving many or few steps depending upon the bidder's reaction and/or desire to purchase the bonds. Ultimately if both sides are unable to reach a compromise, no trade occurs.
- 3.) The dealer may continue to negotiate by countering the bid, offering a compromise price. The new price is known as a "counter" or counter-offer and is intended for only that one dealer situation. The situational process may involve several such steps, finally and ultimately leading to a trade. If both sides cannot agree on price the situation ends at an impasse and no trade occurs.
- 4.) The dealer may "pull the offering" (rescind the offering), indicating his displeasure at the bid level turned in by the potential buyer through the broker's broker. The messenger is always killed in these instances, as the broker's broker is bound by protocol to "reflect" (turn in) all bids to the owner of the offering; good, bad or indifferent-they must show the bid in so the owner knows the current bid in the market.
- 5.) At any point in the situational process either of the dealers may "lock" the other dealer, which means that they agree to the price set by the other dealer and are now negotiating who will pay the broker's broker commission. If one or the other, or both, do not concede on paying the commission, no trade is done.
- 6.) When the market is running a dealer may "bump the offering" (raise the offered price) on the broker's broker. This may technically occur at any point during the situation and, as situations are emotion and ego-filled endeavors, may upset the tenuous balance of these characteristically delicate exchanges. The bid is usually "pulled" (withdrawn) when an offering is bumped, thus quashing that attempt at trading the bonds.