When would a bond be traded flat?

Question

when would a bond trade flat. I.e, accrual is not taken into account in the dirty price? For example US040114HR43 is currently being traded flat.

Answer 1

So the question becomes "Why would a bond trade without its coupon?" Broadly speaking, it will trade without its coupon if the receipt of the coupon is in question. In this specific case, you have a USD based bond from a country (Argentina) that is in financial trouble and has suspended interest payments on its debt. Given that this means there is no coupon being paid and there is no clarity on when they might resume payment of interest, this has started to trade like a defaulted bond and prices on recovery value (about 43 cents currently).

Edit: Note: Trading flat has nothing to do with whether the price is quoted clean price or dirty price. It has to do with whether it is trading with accrued interest or not. I trade Sov Bonds all day and sometimes I am quoted clean price, dirty price, yield, yield spread to the benchmark bond, g-spread, etc., as long as both the counterparty and I understand what the quote means, we are talking the same thing. At settlement, I know I am on the hook for the dirty price (clean price + accrued interest), unless the bond is trading flat (then I am only on the hook for the traded price as there is no accrued interest due.)

Answer 2

Two cases:

1 In a few countries / markets, the traditional market comvention is that bond prices are always quoted "dirty", all-in, including the accrued interest, on proceeds (these are different names for the same concept). For example, in Brazil and Argentina, the local-law bonds are traditionally quoted dirty. For example, BRSTNCNTC0K4 is an NTN-C Brazil local bond (inflation-linked to wholesale inflation index). In particular, in Argentina most (not all) local-law USD-denominated bonds are always quoted dirty (for example ARARGE034678), but external-law USD-denominated bonds like the one you mention are usually quoted clean (but not currently, see below). In Brazil, external-law BRL-denominated (USD-settled) bonds are quoted clean (for example US105756BN96). This is done from the day the bond starts trading and doesn't mean that the bonds are any more credit-risky than bonds quoted clean.

Also preferred equity are bond-like instruments that are always quoted dirty, which doesn't mean that they're likely not to pay their promised dividends.

2 When the market thinks that a bond issuer is close to default, the participants start quoting its bonds dirty. In emerging markets it's actually a little better organizedthan in DM HY: the Emerging Markets Trading Association (EMTA) announces when something should be quoted dirty. You don't need to be an EMTA member to see their announcements. For example, the most recent one:

https://www.emta.org/media/151lnr2o/mkt169.pdf

169. November 27, 2020

Recommended Market Practice for Trades of Suriname Bonds

Following consultations with major market participants, EMTA is recommending that all trades of Suriname Bonds entered into on or after November 30, 2020 should, unless otherwise agreed, trade “flat”.

Accordingly, (1) such trades will settle at an all-in (or ”dirty”) price and without an additional payment in respect of accrued and unpaid interest and (2) Buyers will thereby acquire title to all such interest.

This doesn't mean that Suriname has defaulted on their bonds yet, just that the market participants quote it dirty in anticipation of a possible default.

The bond you mention is an external-law Argentina 6.875% 2048 affected by a similar EMTA recommendation in May 2020 https://www.emta.org/media/xlejhp35/mkt165.pdf

165. May 22, 2020

Recommended Market Practice for Trades of Argentina’s Foreign Law Bonds

Following consultations with major market participants and EMTA’s Advisory Council for Argentina, EMTA is recommending that all trades of Argentina’s Foreign Law Bonds entered into on or after May 25, 2020 should, unless otherwise agreed, trade “flat”. Accordingly, (1) such trades will settle at an all-in (or ”dirty”) price and without an additional payment in respect of accrued and unpaid interest and (2) Buyers will thereby acquire title to all such interest.

also there is an April 2020 EMTA recommendation for the few local-law Argentina bonds that used to be quoted clean https://www.emta.org/media/wogpyj3u/mkt162.pdf :

162. April 9, 2020

Recommended Market Practice for Trades of Argentina Local Bonds

Following consultations with major market participants, as well as EMTA’s Advisory Council for Argentina, EMTA is recommending that all trades of the following Argentina local bonds (which had previously traded “clean” with a separate payment for accrued interest) entered into on or after April 13, 2020 should, unless otherwise agreed, trade “flat”:

ARARGE03E0973.75% Notes due 12/31/2038

ARARGE03G704 3.75% Notes due 12/31/2038

ARARGE3208M1 4% Notes due 8/5/2021

ARARGE03E113 8.28% Notes due 12/31/2033

ARARGE03G688 8.28% Notes due 12/31/2033

Accordingly, (1) such trades will settle at an all-in (or ”dirty”) price and without an additional payment in respect of accrued and unpaid interest and (2) Buyers will thereby acquire title to all such interest.

Please observe that switching from clean to flat doesn't change anything economically. Suppose that before the switch, the quoted clean price was 70 and the accrued was 5. You put those 2 numbeers on the trade ticker, and you paid/received the dirty price of 70+5=75, and also used this dirty price of 75 to calculate the yield, Z-spread, etc. After the switch, the quoted dirty price is still 75. You put that price on the trade ticker and you get the bond for this price. If the bond is still performing, then you can still use the dirty price to calculate the yield and Z-spread. If the bond issuer pays the next coupon, then the bond holder of record gets the entire next coupon, either way. However because there is no accrued mentioned on the ticket, the bond seller and the bond buyer don't get into a dispute over that if the bond issuer doesn't pay. Please note that the Investopedia article on this topic is factually incorrect.

Of course once the bond issuer actually defaults (which Argentina did in May 2020), there is no choice but to quote the dirty price. There is no more coupon accrual. The bond is just a claim on accelerated principal repayment in a bankruptcy courst, trading on recovery assumptions. Yield and Z-spread calculations no longer make much sense because you can't assume that the remainign cash flows will happen.

However the previous time Argentina defaulted, in 2014, the market participants anticipated (correctly) that the suspended coupons would be paid later, and the cash flows would resume. So you had bonds quoted dirty, but one still could calculate their accrueds (which was quite a bit, over a year's worth eventually) as well as yields and Z-spreads assuming that the cash flows would resume unchanged.

If you deal with bond options, you should be careful whether the strike is clean or dirty price. I once saw someone lose almost a million dollars on one trade because she thought she was selling a call referencing a clean price, but instead she sold a contract referencing a dirty price (of a local-law Argentine bond, actually).

The clean price is the same as the dirty price if a trade in coupon-paying bond settles on a day when the bond has zero accrued. Likewise, clean always equal dirty for zero-coupon bonds. Only a positive accrual can make the dirty parice greater than the clean price. However this isn't what people normally mean by trading flat.