Why are bond indexes difficult to calculate?


Why would stock prices be easier to calculate than bond prices, making it stock indexes easier to determine than bond indexes? I read that it has to do with the infrequency at which the bonds trade which makes up-to-date prices difficult to obtain, but I dont get the intuition behind this very well.

In: 3

Well, you kind of said it right there.

A lot of bonds are issued and just held.
An index will calculate the gain based on market prices, but a lot of bond issues just won’t trade at all, or many of them only trade over the counter, not in live bidding markets.

It’s also not uncommon for bonds to be swapped. Two companies will agree to exchange a fixed rate for a variable rate or something, and that price isn’t reflective of the true price.

There’s also other factors in bonds, such as convertibility that may make them not comperable to other bonds with similar stats.

Basically stocks are very liquid and all the same, Bonds aren’t as liquid and are too different from one another

Let’s pretend I’m going to a market where all kinds of apples are sold. Let’s say that for the day, Granny Smith apples were sold somewhere between $1 and $1.10 all day long an the last price was $1.09. Let’s also pretend you have a way of seeing all the sales that took place.

If you’re thinking of buying an apple, unless you are aware of an impeding shortage, you would think it’s reasonable you should pay as close as possible to $1.09. It’s a pretty reasonable guess because lots of people have been buying Granny Smith apples near that price, it’s a market specialized in apples after all. Let’s pretend that there is a law that forces me to give you an accurate price if you ask me at any time.

Now, let’s also imagine that I have a special kind of apple, a blue apples. Now blue apples are pretty niche, they are not useless, but they are not sold very often. They are only for connoisseurs. Last month, somebody bought one for $2.10, but the month before, it was $3.5. If you ask me for a price right this minute, well, I don’t really have a good way to find out a reasonable price. Maybe I can assume that the price behaves similarly to Granny Smith, or maybe I’m just gonna decide that it has to fall between $2.10 and $3.50, but at the same time, remember, there is this law that forces me to quote you an accurate price, so I have to be able to have a reasonable explanation as to why this should be the price.

A Bond Index Fund tries to mimic the overall Bond Market. Lots of bonds are traded very often (like bonds from the government and big corporations), but some bonds are traded much less often, so it’s hard to figure out what your index should be if a non-negligible portion of your fund doesn’t trade very often. All you can do is make reasonable assumptions, bearing in mind it is a heavily regulated industry and you need to be ready to defend your assumptions.

It’s not difficult to calculate.

But, unlike stock, bonds have different return regarding to its maturity (or term structure) of which is not applicable to be grouped together to represent in a single index.