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Marketability of bonds

+1 vote
asked Jul 29, 2018 in BUS 4027W - Actuarial Risk Management by anonymous

I read in the ActEd notes that in general, index-linked bonds are less marketable than conventional bonds (solution to question 22.1). 

Why does this make sense? I thought that because of the inflation protection, more people would want index linked bonds and this makes it more marketable?

1 Answer

+2 votes
answered Jul 31, 2018 by PBotha (490 points)

Hi! Well done on reading so far in advance!! :) 

The marketability referred to here means the ease of buying and selling at the price you want with minimum dealing costs.

Government bonds are issued in much smaller tranches than conventional bonds, making them less marketable.  Also, their overall expected return is likely to be lower than on conventional bonds (has an inflation risk premium in addition to expected inflation in the expected return formula, whereas ILB's provide only inflation protection - no upside above that) - this reduces demand and the ease at which they can be sold - lower marketability

Other things might include the availability and size of issues of particular terms to match investors' liabilities - if only limited ones available, then reduced demand and marketability, and with small issues, dealing costs are likely to be higher.

Hope this makes sense! (This is in general - in particular cases when inflation uncertainty is extremely high, ILB's may be more marketable because people value the inflation protection more than the potential upside of the risk premia, but generally not the case)