Bonds trade over the counter. There is no central limit order book for most of the market, and what replaces it is a set of dealers who quote two-way prices and hold inventory.
A dealer who buys from you at the bid and sells to somebody else at the ask earns the spread for providing immediacy and for carrying the position in between.
That makes the bid-ask a price rather than a friction. It buys the ability to transact now instead of waiting for a natural counterparty, and it widens exactly when immediacy is scarce: in a selloff, in an issue nobody else owns, in a size larger than a dealer wants on its balance sheet.
It is therefore widest on the day you most want it narrow.
What is the on-the-run premium and what does it cost?
The most recently auctioned security at each benchmark tenor is on-the-run. It is where hedging flow concentrates, where the tightest quotes live, and it commands a price premium, meaning a lower yield, for that liquidity. When the next auction happens the old benchmark becomes off-the-run and cheapens. The concession is real money and so is the cost of capturing it.
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Worked Example 7 puts numbers on both halves. An on-the-run ten-year Treasury quoted 99-14+ / 99-15 has a bid-ask of 0.0156250000 per 100, which is one sixty-fourth. An off-the-run issue quoted 96-08 / 96-12 has a bid-ask of 0.1250000000, which is four thirty-seconds and eight times as wide. On $50,000,000 of face the round trips are $7,812.50 and $62,500.00. At a modified duration of 8.0 those spreads are 0.196371 and 1.622323 basis points of yield respectively. If the off-the-run pays 6 basis points more, which is $30,000.00 a year on that face value, the extra $54,687.50 of round-trip cost takes 1.82291667 years to recover. Buy the concession for a year and you have paid for the privilege of earning it.
The Indian version of the same arithmetic is starker because the liquidity gradient is steeper. On ₹100 crore of face, a benchmark government security quoted 2 paise wide costs ₹2,00,000 to round-trip and a state development loan quoted 15 paise wide costs ₹15,00,000. A 35 basis point pickup on the state loan is ₹35,00,000 a year, so the extra cost is recovered in 0.37142857 years, about four and a half months. The state loan looks like the better trade on that arithmetic, and it usually is, provided the quoted spread is available in your size on the day you need to sell. That proviso is the entire risk.
How transparent are bond prices?
Price transparency differs sharply by market and is worth knowing because it decides what data you can get. In the United States, corporate bond transactions are reported to the industry's trade reporting facility and disseminated publicly, and municipal transactions are published on the regulator's own disclosure portal, so a retail investor can see where a bond actually traded. In India, government securities trade on an anonymous order-matching platform operated by the clearing corporation, which gives that market genuine pre-trade transparency. Corporate bonds there trade over the counter, with reporting to exchange platforms and a request-for-quote facility layered on top (check the current platform set and reporting rules with SEBI, the RBI and CCIL).
The practical consequence is that an Indian corporate bond's last traded price may be weeks old. That is precisely why the valuation matrices published by the market body exist, and why matrix pricing is not an academic exercise there.