November 22, 2019
The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, but it may include notes, bills, and so on. A global bond is a bond which is issued in several countries at the same time and is issued by a large multinational corporation or sovereign entity with a high credit rating. By offering the bond to many investors, a global issuance can reduce borrowing cost. These bonds are usually issued by large multinational organizations and sovereign entities, both of which regularly carry out large fund-raising exercises. By issuing global bonds, an issuing entity is able to attract funds from a vast set of investors and reduce its cost of borrowing. Global bonds are issued in different currencies and distributed in the currency of the country where it is issued. Bonds are loaned in terms of years.
1. The bond market is much larger than the stock market.
According to some estimates, the global bond market has more than tripled in size in the past 15 years and now exceeds $100 trillion. In U.S. alone for instance, bond markets cover almost $40 trillion in value, compared to less than $20 trillion for the domestic stock market.
2. Bond prices can be volatile.
Bond prices can move violently when interest rates change.
3. Some bonds have an equity kicker.
Companies often choose convertible bonds to lower the rate they have to pay on their debt. If the stock rises dramatically, then the convertible bond will typically give holders substantial gains. Yet if the stock doesn’t perform well, the bond still pays back its principal amount at maturity.
4. Bond ratings can make a big difference.
Higher bond ratings typically have less chance of default, and so issuers can pay lower interest rates and still get demand.
5. Not all bonds from a given company are created equal.
Sometimes, the maturity date will define the relative order of priority for a bond to get repaid, letting you predict whether you’d be able to recover your principal if the company ran into financial trouble.
Why the bond market is important?
Its primary goal is to provide long-term funding for public and private expenditures. The bond market is part of the credit market, with bank loans forming the other main component. Bonds typically are regulated, not secured by collateral and are sold in relatively small denominations of around $1,000 to $10,000. Unlike bank loans, bonds may be held by retail investors. Bonds are more frequently traded than loans, although not as often as equity.
The Securities Industry and Financial Markets Association (SIFMA) classifies the broader bond market into 5 specific bond markets.
How are bonds traded in the market?
Stocks and bonds are two of the most traded items—each available for sale on different platforms or through a variety of markets. Stocks are shares, known as equity, in a publicly-traded company. Bonds are basically a fixed-income loan the investor makes to a government or corporate entity.
Where Bonds are Traded
The bond market does not have a centralized location to trade, meaning bonds mainly sell over the counter (OTC). As such, individual investors do not typically participate in the bond market. Those who do, include large institutional investors like pension funds foundations, and endowments, as well as investment banks, hedge funds, and asset management firms. Individual investors who wish to invest in bonds do so through a bond fund managed by an asset manager.
Bonds are normally given an investment grade by a bond rating agency like Standard & Poor’s and Moody’s. This rating—expressed through a letter grade—tells investors how much risk a bond has of defaulting. A bond with a “AAA” or “A” rating is high-quality, while an “A”- or “BBB”-rated bond is medium risk. Bonds with a BB rating or lower are considered to be high-risk.
One major difference between the bond and stock markets is that the stock market has central places or exchanges where stocks are bought and sold. The other key difference is the risk involved in investing in each. Bonds are more susceptible to risks such as inflation and interest rates. When interest rates rise, bond prices tend to fall.
What are the disadvantages of bonds?
The disadvantages of bonds include rising interest rates, market volatility and credit risk. Bond prices rise when rates fall and fall when rates rise. Your bond portfolio could suffer market price losses in a rising rate environment. Bond market volatility could affect the prices of individual bonds, regardless of the issuers’ underlying fundamentals.
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