A bond market is a financial marketplace where investors engage in the buying and selling of bonds. Nowadays, these transactions are mostly conducted electronically via computers. There are two main types of bond markets: primary markets, where companies can issue new debt, and secondary markets, where investors can buy and resell existing debt securities.
While bonds are the primary focus of these markets, other debt instruments such as bills, notes, and commercial paper are also traded. The primary purpose of bond markets is to help private companies and public entities secure long-term funding. Historically, the United States has been the dominant force in the global bond market, accounting for approximately 44% of its total value.
According to the Securities Industry and Financial Markets Association (SIFMA), there are five major bond markets: municipal, corporate, mortgage or asset-backed, funding, and government or agency markets. The government bond market is particularly significant due to its large size and liquidity.
Because of the stability of U.S. and certain international government bonds, these bonds are often used as benchmarks to assess the credit risk of other bonds. Government bonds, particularly those issued by countries with strong economies like the United States, United Kingdom, or Germany, are often considered to be virtually risk-free in terms of default. Consequently, bonds issued in these countries’ currencies offer lower yields compared to other bonds, which are seen as having a higher likelihood of default.
Beyond their primary function of facilitating debt issuance and trading, bond markets play a crucial role in signaling interest rate trends. This is because bond values have an inverse relationship with interest rates, providing investors with a means to gauge the true cost of borrowing. Companies perceived as riskier must offer higher interest rates on their bonds compared to those with strong and stable credit profiles.
When companies or governments face difficulties in making full or partial payments on their bonds, this is termed a default. Bonds are an alternative to issuing stock for raising funds; they are contracts between issuers (borrowers) and investors (lenders). When investors buy bonds, they are essentially lending money to the issuing company or government, which promises to repay the original investment along with interest at a future date.
All bonds have certain common features, regardless of the specific market they are traded in. These include the face value, which is the amount the bond is worth at maturity and the basis for interest payments; the coupon rate, which is the interest rate paid by the issuer; coupon dates, which are the scheduled times for interest payments; the issue price, which is the initial selling price of the bond; and the maturity date, which is when the bond is repaid and the issuer returns the face value to the bondholder.
While some investors hold bonds until maturity, many buy and sell them in the bond markets as their financial needs change. Bonds can be sold at a premium if their market value exceeds the original face value or at a discount if their market value falls below the face value. This flexibility in trading allows investors to adjust their portfolios and potentially capitalize on market movements before the bond’s maturity date.
