Imagine you are a credit analyst reviewing the portfolio of a mid-sized Indian corporate bond fund. You notice a substantial holding in unlisted non-convertible debentures (NCDs) issued by a growing infrastructure firm. While the internal valuation model shows a healthy yield-to-maturity, your supervisor asks you to assess the ’exit’ feasibility if the firm’s credit rating outlook shifts to negative. You quickly realize that while the bond is theoretically solvent, there is virtually no secondary market for this specific instrument. This is the practical difference between liquidity and marketability.
Asset marketability is the ease and speed with which a specific financial instrument can be converted into cash without causing a significant price concession. In the Indian debt market, government securities (G-Secs) exhibit high marketability because they are traded actively on the NDS-OM platform, allowing for large-block trades with minimal impact on pricing. Conversely, many corporate bonds, especially those issued by smaller entities or those that are privately placed, lack market depth.
Even if the issuer is financially sound, the lack of interested buyers at any given moment renders the asset essentially illiquid.
From a valuation perspective, an analyst must incorporate a ’liquidity premium’ into the required rate of return for less marketable assets. If a bond is difficult to move, the investor demands a higher yield to compensate for the inability to liquidate the position during adverse market events. When building a valuation model, ignoring marketability leads to a gross underestimation of risk.
You must distinguish between the ‘fair value’ derived from a discounted cash flow model and the ‘realizable value’—the price you can actually obtain in a stressed market environment where buyers may be non-existent.
Consider the contrast between a highly liquid AAA-rated PSU bond and a BBB-rated private sector bond in a period of systemic volatility. During a credit squeeze, the PSU bond will likely see price fluctuations based on interest rate movements, but it will continue to trade regularly. The BBB-rated bond, however, may become ‘stale,’ with no quoted prices and wide bid-ask spreads, forcing an investor to hold until maturity regardless of the opportunity cost.
Assessing marketability forces the analyst to look beyond the balance sheet and consider the plumbing of the secondary market, ensuring the portfolio remains robust even when market sentiment turns sour.
Nuance
Check Your Understanding
An analyst is comparing two corporate bonds: Bond X, a widely held bond listed on the NSE with daily trading volume, and Bond Y, an unlisted private placement bond. Why is Bond Y inherently riskier from a marketability perspective?
How should an analyst adjust their valuation model when encountering a bond with extremely low marketability?
This is a companion read for Section 9.3 — Risks associated with fixed income securities from PASS Investment Adviser (Level 1) by Akhilesh Gururani, available on Amazon Kindle.
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