Bond Spread Question

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cfalevel_1

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Compute the bid-asked spread for the following bond:

Dealer Bid Asked
1 100 1/32 100 5/32
2 100 4/32 100 6/32
3 100 2/32 100 5/32

Answer is .03125

(100 5/32) - (100 4/32) = 1/32 = .03125

Can anybody explain this to me? Why it was done this way
 
Remeber the topic about the secondary market of the bond? The T-Bond & Notes are quated in this way (percent & 32nds of 1%) in the seconday market.

WHAT IS THE ESSENCE OF THIS?

Remeber the liquidity risK?
The wider the spread of Bid & Ask -> The less the lequidity of the security-> tend to dicrease the price of the security & the investor or the holder will require a higher yield.
Therefore, the bid&ask spread is the measure of liquidity of a security -> the less the spread the more liquid the security & the widder the spread the less liquid the security. And for the case in measuring the liquidity of the T-Bonds & Notes, they are measured in terms of the Bid&Ask spread of "1xx% of xx/32".

Hope it will help! :)
 
That was totally non-responsive...


You would buy from dealer 1 or 3 and sell to dealer 2. Thus, the market bid/ask is 1/32.
 
The question asked for the bid/ask spread, not some core dump about liquidity (not relevant to the question), T-Bonds and Notes (not mentioned explicitly in the question), the relationship between liquidity and spread (not mentioned in the question), the relationship between liquidity and price (not mentioned in the question). The question did ask why the spread was 1/32 and you didn't answer it. When you get to LIII and start writing essay questions, the above answer is the kind that takes a long time and gets a 0.
 
Basically a bid is the person's price he would pay.
And an ask is how much he will sell that security for.

Simplified:
Bid = Buy
Ask = Sell

A "market" is defined by the highest bid and the lowest offer asked.

Thus:
Highest bid = 100 4/32
Lowest ask = 100 5/32

The "bid-ask spread" is the difference between the two 100 5/32 - 100 4/32 = .03125.


Additional info:
The bid-ask spread is indirectly proportional to the liquidity of the security.
It is also the means by which "market-makers" make money [their "edge"].
It is never (under normal conditions) equal to 0, because that means someone is willing to buy and someone else is willing to sell at the same price.


Hope this helps.
 
Well anyways you really true about the "not some core dump about liquidity", about the T-Bond & T-Notes, and the relationship of liquidity and spread and further also to the price. Yeah I probably not answer the question you know why? I just base my simple answer to what is cover in the CFA level 1 exam and it was in Fixed Income. introduce in the reading 63 LOS k, and further tackled in reading 64 LOS b, and it was thoroughly discussed in reading 65. Take note the subject of the post "BOND Spread Question" and it was post in here in level 1. So prof. JoeV that's why I don't get why you say "That was totally non-responsive... " and oh yeah the question...

"Compute the bid-asked spread for the following bond:

Dealer Bid Asked
1 100 1/32 100 5/32
2 100 4/32 100 6/32
3 100 2/32 100 5/32 "

I didn't incounter it in CFA text (though might be I don't answer the end-reading question in Fixed income) and surely niether in schweser. So the way the question constructed and where it is post, surely your answer will be base on what level of the exam and in what specific subject it cover.

But well thanks for the advice regarding the level 3 (though I'm a level 1 2008 candidate) at least it give me an idea about the essay type exam.
 
Ooops I forgot to mention. the "Bond Spread Question" might also be covered in some reading session and not only in Fixed Income (probably in equity part) though I am not yet done entirely in the Level 1 materials. But again, I just limit my answer in fixed income co'z that is where the ideal answer might come from.
 
Hi cfalevel_1,
The difference between the maximum price the bidder is willing to pay and the minimum price the seller is asking for it is called the Big-Assed spread (said in Olinto's tone..)

So take the MAX(Column 2) - MIN (Comumn 3) and that's the answer.


Logimech,
Could you elaborate more on your 2nd point??

- Dinesh S
 
Dinesh-

Market makers are traders that provide liquidity on the market by constantly quoting bids and asks. When you place a market order on eTrade, you are able to instantly have that order filled because the market makers are there on the other side to take your trade. In exchange for that liquidity, they want to earn a profit (the bid-ask spread).

Say the "true value" of a stock is $50 but the market makers are quoting bid-ask of $49-$52.

This means they are demanding an extra $1 on the buy side and $2 on the sell side. This is also called their "edge."

Market makers need an edge for a variety of reasons. Mostly, they need to compensate for the risk they are taking from holding a position.

Their ideal goal is to close out all their positions as fast as possible, which in this example is to buy a stock at $49 and sell it at $52 and walk away with the $3 profit. However because they are *taking* orders rather than *placing* them they need to wait until the appropriate customers come.


Anyway, I think this is all outside the scope of the CFA Level I... but I hope it helps.

-Logi
 
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