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It's no secret that trading spreads for bonds are atrociously wide compared to stock bid and ask spreads, and, therefore, there is going to be a difference between the price at which you bought your bonds today and the price at which they are likely to be marked to market when the brokerage firm posts the trade the next morning.

For high-grade issues that are widely traded this valuation spread might be only a half point or so. For junk issues, especially those with depressed prices, the difference between the trading offer and the price at which the bond will be marked to market if you buy it runs as much as 5 or 6 points, from my limited experience. I don't like it, but that's the junk market and you either learn to deal with it or you trade something else.

But I've never seen a 10+ point spread until this morning when I bought some Marconi 7.75's of '10 at 80.903 at Schwab yesterday and see they are marked to market at 70 something today. This was the first time I've used Schwab, so I don't know whether they are merely very conservative about how they value a customer's bonds, or whether the the valuation spread is really that wide. At E*Trade I can generally verify their valuations by pulling closing quotes from HyMarket (a junk bond boutique.) 95% of the time the two figure agree, which also makes it easy to know in advance where to set my limit orders when I'm trying to buy something. Sometimes I can get a fill. Other times E*Trade tells me that "my price is too far from the market" and I just pass on the issue rather than chase the price.

HyMarket didn't have a quote for Marconi, but other firms had the following offers:

E*Trade 82.512
Waterhouse 82.820
CSFB 82.075
Schwab 80.903

I know Marconi is in trouble, as are all of the telecos, others of whose bonds I also own, that the stock has crashed badly, and that S&P and Moody's both have put the company on negative credit watch, etc., so I thought I was going into the situation reasonably well forewarned, but I seem to have guessed wrong.

Whether the issue is appropriate for your own portfolio is something each investor has to decide for him/herself, but if you are interested in buying the issue, don't hesitate to use a very, very aggressive limit order in an attempt to cut the spread as much as possible. You might not get a fill, but that might also be a good thing. (I'm always worried when I bid close to the bid but still get a fill.)

Charlie


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Hi Charlie,

You wrote
But I've never seen a 10+ point spread until this morning when I bought some Marconi 7.75's of '10 at 80.903 at Schwab yesterday and see they are marked to market at 70 something today. This was the first time I've used Schwab, so I don't know whether they are merely very conservative about how they value a customer's bonds, or whether the the valuation spread is really that wide


I have had similar things happen with both Schwab and Merrill Lynch. I called both firms and was given essentially the same story from both. They stated that on bonds that they do not have in their inventory, and that are not traded on an exchange, they use a bond pricing service to price the bonds.

These prices, they said, were to be used as a guide.

When I am interested in purchasing this type of bond, I go to Bonds on Line or Yahoo to check prices. I usually go to three dealers for quotes. I use Brown, Merrill and Schwab. When the quotes come in, I order the lowest priced bonds. Normally the price I pay is less than shown on either of the web sites. If There are a number of different offerings of the same bond shown on the web site, I may make a counter offer lower than the price I was quoted.

Dan
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Dan,

I did check multiple sources for quotes before I bought and found that the trading spread - aka, the range between the bid and the offer - at four firms was about two points, which is fairly typical. My surprise was the huge gap between what I paid and what I was told the next day the bond were now considered to be worth, aka, their marked-to-market value, which I realize is often a calculated value [from matrix pricing] rather than a report of actual closing prices, because, as you say, the bonds are thinly traded and the firms don't have any in inventory.

I'm seeing that sort of discrepency on my Inland Steel bonds. One day they are marked to market at 68 , the next at 78, and then back to 68, yo-yo, fashion, huge moves that likely have nothing to do with how the bonds were traded that day but more to do with backoffice, automated pricing schemes. Whereas an actively traded issue like Tommy Hilfinger moves every day by quarters and halves and its mark-to-market value is easy to confirm from a lot of sources.

It wouldn't surprize me if the market makers for Marconi bonds were artificially supporting the price, which I've seen happen with Sterling Chemical's bonds, where I could find from other sources reported trades at 6 points under E*Trade's current offer, but I couldn't get a fill from them unless I was willing to buy at the offer, and my concern was to warn potential buyers of Marconi bonds - wherever they are trading - that rather than bid anywhere close to the offer, they ought to knock eight to ten points off and try for that price instead and obtain for themselves a better price than I seem to have ended up with.

Sometimes I win the pricing war and by the end of the day I'm in the money on an new position from where I bought, even after deducting commisions. Other times, I take a beating for a couple of weeks or even months until the company or market turns around as I was anticipating. I buy with the expectation that the company will be filling Chapter 11 sooner or later and that my loss rate is going to be about what the five-year historical default rate is for triple CCC's, or ~5-8%. Not a problem. If this stuff were easy and safe, there'd also be no money in it.

Thanks for your input.

Charlie
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I have seen this sort of thing happen even with listed preferred stocks traded on major exchanges. One suspects "bucket trading" when the price goes up sharply for your order and then declines to its previously posted market value.

In thinly traded stocks, its a common problem. Its a good reason never to place a market order for a thinly traded stock--especially a preferred stock.
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