What is a Bond Market?

Published by Thomas Herold in Corporate Finance, Investments, Trading

'Bond Market' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A bond market is a financial market where investors buy and sell bonds. In practice this is mostly handled electronically over computers nowadays. There are two principal types of bond markets. These are primary markets where companies are able to sell new debt and secondary markets where investors are able to purchase and resell these debt securities. Companies generally issues such debt as bonds. These markets also trade bills, notes, and commercial paper.

The goal of the bond markets is to help private companies and public entities obtain funding of a long term nature. This market has generally been the domain of the United States that dominates it. The U.S. comprises as much as 44% of this bond market on a global basis.

There are five primary bond markets according to SIFMA the Securities Industry and Financial Markets Association. These include the municipal, corporate, mortgage or asset backed, funding, and government or agency markets. The government bond market comprises a significant component of this market thanks to its massive liquidity and enormous size. Because of the stability of U.S. and some international government bonds, other bonds are often contrasted with them to help determine the amount of credit risk.

This is because government bond yields from countries with little risk like the U.S., Britain, or Germany are traditionally considered to be free of default risk. Other bonds denominated in these various currencies provide greater yields as the borrowers are more likely to default than these central governments.

Bond markets often serve a useful secondary function to reveal interest rate changes. This is because the values of bonds are inversely related to the interest rates which they pay. This helps investors to measure what the true cost of obtaining funding really is. Companies which are perceived to be riskier will have to pay higher interest rates on their bonds than companies believed to have strong and stable credit and repayment abilities. When companies or government entities are unable to make a partial or full payment on their bonds, this becomes a default.

When a company or a government needs to raise money and does not want to issue stock, it can sell bonds. These are contracts the issuers who are the borrowers make with investors who function as lenders. When investors purchase such instruments, they lend money to the issuing organization (company or government). The issuer of the bond promises to repay the original investment back along with interest in the future.

Bonds traded on these markets have many elements in common, whichever type of market they represent. All bonds have a face value. This is the amount of money which a bond would be valued at when it matures and the amount on which interest payments are based. They also have coupon rates that represent the interest rate which the issuer of the bond pays in its interest payments.

The coupon dates turn out to be the times when the  issuer will pay its interest payments. Issue prices are the amounts for which the issuer sells the bond in the first place. The maturity date proves to be the exact date when the bond would be repaid. At this time, the issuer of the bond would pay the bond’s face value to the bond holder.

Though a holder of a bond might keep it until maturity, this is often not the case. Many investors buy and sell them on the bond markets as their needs dictate. It is possible to sell a bond at a premium when the market value becomes greater than the original face value. Investors could also sell them at a discount to their original face value as the market price declines.

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The term 'Bond Market' is included in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.