The bond market (also debt market or credit market) is a
financial market
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial market ...
where participants can issue new
debt
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
, known as the
primary market :''"Primary market" may also refer to a market in art valuation.''
The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the issuer, with the issuer being paid the proce ...
, or buy and sell debt
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
, known as the
secondary market. This is usually in the form of
bonds, but it may include notes, bills, and so on for public and private expenditures. The bond market has largely been dominated by the United States, which accounts for about 39% of the market. As of 2021, the size of the bond market (total debt outstanding) is estimated to be at $119
trillion
''Trillion'' is a number with two distinct definitions:
* 1,000,000,000,000, i.e. one million million, or (ten to the twelfth power), as defined on the short scale. This is now the meaning in both American and British English.
* 1,000,000,000,0 ...
worldwide and $46
trillion
''Trillion'' is a number with two distinct definitions:
* 1,000,000,000,000, i.e. one million million, or (ten to the twelfth power), as defined on the short scale. This is now the meaning in both American and British English.
* 1,000,000,000,0 ...
for the US market, according to
Securities Industry and Financial Markets Association
The Securities Industry and Financial Markets Association (SIFMA) is a United States industry trade group representing securities firms, banks, and asset management companies. SIFMA was formed on November 1, 2006, from the merger of the Bond M ...
(SIFMA).
Bonds and bank loans form what is known as the ''credit market''. The global credit market in aggregate is about three times the size of the global equity market. Bank loans are not securities under the Securities and Exchange Act, but bonds typically are and are therefore more highly regulated. Bonds are typically not secured by collateral (although they can be), 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.
Nearly all of the average daily trading in the U.S. bond market takes place between
broker-dealers and large institutions in a decentralized
over-the-counter
Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid prescr ...
(OTC) market.
[Avg Daily Trading Volume](_blank)
SIFMA 1996 - 2016 Average Daily Trading Volume. Accessed April 15, 2016. However, a small number of bonds, primarily corporate ones, are listed on
exchanges. Bond trading prices and volumes are reported on
Financial Industry Regulatory Authority
The Financial Industry Regulatory Authority (FINRA) is a private American corporation that acts as a self-regulatory organization (SRO) that regulates member brokerage firms and exchange markets. FINRA is the successor to the National Associat ...
's (FINRA)
Trade Reporting And Compliance Engine, or TRACE.
An important part of the bond market is the
government bond
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
market, because of its size and
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liq ...
. Government bonds are often used to compare other bonds to measure
credit risk
A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
. Because of the inverse relationship between
bond valuation
Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a ...
and interest rates (or yields), the bond market is often used to indicate changes in interest rates or the shape of the
yield curve
In finance, the yield curve is a graph which depicts how the yields on debt instruments - such as bonds - vary as a function of their years remaining to maturity. Typically, the graph's horizontal or x-axis is a time line of months or ye ...
, the measure of "cost of funding". The yield on government bonds in low risk countries such as the United States or Germany is thought to indicate a risk-free rate of default. Other bonds denominated in the same currencies (U.S. Dollars or Euros) will typically have higher yields, in large part because other borrowers are more likely than the U.S. or German Central Governments to default, and the losses to investors in the case of default are expected to be higher. The primary way to default is to not pay in full or not pay on time.
Types
The
Securities Industry and Financial Markets Association
The Securities Industry and Financial Markets Association (SIFMA) is a United States industry trade group representing securities firms, banks, and asset management companies. SIFMA was formed on November 1, 2006, from the merger of the Bond M ...
(SIFMA) classifies the broader bond market into five specific bond markets.
*
Corporate
A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and r ...
*Government and agency
*
Municipal
A municipality is usually a single administrative division having corporate status and powers of self-government or jurisdiction as granted by national and regional laws to which it is subordinate.
The term ''municipality'' may also mean the go ...
*
Mortgage-backed, asset-backed, and
collateralized debt obligation
A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Le ...
s
*Funding
Participants
Bond market participants are similar to participants in most
financial market
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial market ...
s and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.
Participants include:
*
Institutional investors
*Governments
*
Traders
*Individuals
Because of the specificity of individual bond issues, and the lack of liquidity in many smaller issues, the majority of outstanding bonds are held by institutions like
pension funds
A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income.
Pension funds typically have large amounts of money to invest and are the major investors in listed and priva ...
, banks and
mutual funds
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
. In the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...
, approximately 10% of the market is held by private individuals.
Size
Amounts outstanding on the global bond market increased by 2% in the twelve months to March 2012 to nearly $100 trillion. Domestic bonds accounted for 70% of the total and international bonds for the remainder. The United States was the largest market with 33% of the total followed by
Japan (14%). As a proportion of global GDP, the bond market increased to over 140% in 2011 from 119% in 2008 and 80% a decade earlier. The considerable growth means that in March 2012 it was much larger than the global equity market which had a market capitalisation of around $53 trillion. Growth of the market since the start of the economic slowdown was largely a result of an increase in issuance by governments. In terms of number of bonds, there are over 500,000 unique corporate bonds in the US.
The outstanding value of international bonds increased by 2% in 2011 to $30 trillion. The $1.2 trillion issued during the year was down by around a fifth on the previous year's total. The first half of 2012 was off to a strong start with issuance of over $800 billion. The United States was the leading center in terms of value outstanding with 24% of the total followed by the UK 13%.
Bond Markets 2012 report
U.S. bond market size
According to the Securities Industry and Financial Markets Association (SIFMA),
[ SIFMA Statistics] as of Q1 2017, the U.S. bond market size is (in billions):
Note that the total federal government debts recognized by SIFMA are significantly less than the total bills, notes and bonds issued by the U.S. Treasury Department,
[
Treasury Bulletin] of some $19.8 trillion at the time. This figure is likely to have excluded the inter-governmental debts such as those held by the
Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
and the
Social Security Trust Fund
The Federal Old-Age and Survivors Insurance Trust Fund and Federal Disability Insurance Trust Fund (collectively, the Social Security Trust Fund or Trust Funds) are trust funds that provide for payment of Social Security (Old-Age, Survivors, and D ...
.
Volatility
![TMXGroup5](https://upload.wikimedia.org/wikipedia/commons/e/e8/TMXGroup5.JPG)
For market participants who own a bond, collect the coupon and hold it to maturity, market
volatility is irrelevant; principal and interest are received according to a pre-determined schedule.
But participants who buy and sell bonds before maturity are exposed to many risks, most importantly changes in interest rates. When interest rates increase, the value of existing bonds falls, since new issues pay a higher yield. Likewise, when interest rates decrease, the value of existing bonds rises, since new issues pay a lower yield. This is the fundamental concept of bond market volatility—changes in bond prices are inverse to changes in interest rates. Fluctuating interest rates are part of a country's
monetary policy
Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often a ...
and bond market volatility is a response to expected monetary policy and economic changes.
Economists' views of
economic indicator
An economic indicator is a statistic about an economic activity. Economic indicators allow analysis of economic performance and predictions of future performance. One application of economic indicators is the study of business cycles. Economic ...
s versus actual released data contribute to market volatility. A tight consensus is generally reflected in bond prices and there is little price movement in the market after the release of "in-line" data. If the economic release differs from the consensus view, the market usually undergoes rapid price movement as participants interpret the data. Uncertainty (as measured by a wide consensus) generally brings more volatility before and after a release. Economic releases vary in importance and impact depending on where the economy is in the
business cycle
Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examin ...
.
Bond investments
Bonds typically trade in $1,000 increments and are priced as a percentage of
par value
Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value).
Bonds
A bond selling at par is priced at 100% of face valu ...
(100%). Many bonds have minimums imposed by the bond or the dealer. Typical sizes offered are increments of $10,000. For broker/dealers, however, anything smaller than a $100,000 trade is viewed as an "odd lot".
Bonds typically pay interest at set intervals. Bonds with fixed coupons divide the stated coupon into parts defined by their
payment schedule
The payment schedule of financial instruments defines the dates at which payments are made by one party to another on for example a bond or derivative. It can be either customised or parameterised.
Parameterised Schedule
The schedule is generated ...
, for example, semi-annual pay. Bonds with floating rate coupons have set calculation schedules where the floating rate is calculated shortly before the next payment.
Zero-coupon bond
A zero coupon bond (also discount bond or deep discount bond) is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zero- ...
s do not pay interest. They are issued at a deep discount to account for the implied interest.
Because most bonds have predictable income, they are typically purchased as part of a more conservative investment scheme. Nevertheless, investors have the ability to actively trade bonds, especially
corporate bonds
A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of ...
and
municipal bonds
A municipal bond, commonly known as a muni, is a bond issued by state or local governments, or entities they create such as authorities and special districts. In the United States, interest income received by holders of municipal bonds is often, ...
with the market and can make or lose money depending on economic, interest rate, and issuer factors.
Bond
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
is taxed as ordinary income, in contrast to
dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...
income, which receives favorable taxation rates. However many government and municipal bonds are exempt from one or more types of taxation.
Investment companies allow individual investors the ability to participate in the bond markets through
bond fund
A bond fund or debt fund is a fund that invests in bonds, or other debt securities. Bond funds can be contrasted with stock funds and money funds. Bond funds typically pay periodic dividends that include interest payments on the fund's underlyi ...
s,
closed-end funds and
unit-investment trusts. In 2006 total bond fund net inflows increased 97% from $30.8 billion in 2005 to $60.8 billion in 2006.
[Bond fund flows](_blank)
SIFMA. Accessed April 30, 2007. Exchange-traded funds (ETFs) are another alternative to trading or investing directly in a bond issue. These securities allow individual investors the ability to overcome large initial and incremental trading sizes.
Bond indices
A number of bond indices exist for the purposes of managing portfolios and measuring performance, similar to the
S&P 500
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
or
Russell Indexes Russell indexes are a family of global stock market indices from FTSE Russell that allow investors to track the performance of distinct market segments worldwide. Many investors use mutual funds or exchange-traded funds based on the FTSE Russell I ...
for
stocks. The most common American benchmarks are the
Barclays Capital Aggregate Bond Index The Bloomberg US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in ...
,
Citigroup BIG and
Merrill Lynch Domestic Master The Merrill Lynch Domestic Master is a common American Bond index, analogous to the S&P 500 for stocks, owned by Merrill Lynch. The Domestic Master is similar to the Salomon BIG or the Barclays Capital Aggregate Bond Index (The Agg). The Domestic ...
. Most indices are parts of families of broader indices that can be used to measure global bond portfolios, or may be further subdivided by
maturity or sector for managing specialized portfolios.
History
In ancient
Sumer, temples functioned both as places of worship and as banks, under the oversight of the priests and the ruler. Loans were made at a customary fixed 20% interest rate; this custom was continued in
Babylon,
Mesopotamia
Mesopotamia ''Mesopotamíā''; ar, بِلَاد ٱلرَّافِدَيْن or ; syc, ܐܪܡ ܢܗܪ̈ܝܢ, or , ) is a historical region of Western Asia situated within the Tigris–Euphrates river system, in the northern part of the ...
and written into the
Code of Hammurabi.
The first known bond in history dates from circa 2400BC in
Nippur,
Mesopotamia
Mesopotamia ''Mesopotamíā''; ar, بِلَاد ٱلرَّافِدَيْن or ; syc, ܐܪܡ ܢܗܪ̈ܝܢ, or , ) is a historical region of Western Asia situated within the Tigris–Euphrates river system, in the northern part of the ...
(modern-day
Iraq
Iraq,; ku, عێراق, translit=Êraq officially the Republic of Iraq, '; ku, کۆماری عێراق, translit=Komarî Êraq is a country in Western Asia. It is bordered by Turkey to the north, Iran to the east, the Persian Gulf and K ...
). It guaranteed the payment of grain by the principal. The surety bond guaranteed reimbursement if the principal failed to make payment. Corn was the currency of that time period.
In these ancient times, loans were initially made in cattle or grain from which interest could be paid from growing the herd or crop and returning a portion to the lender. Silver became popular as it was less perishable and allowed large values to be transported more easily, but unlike cattle or grain could not naturally produce interest. Taxation derived from human labor evolved as a solution to this problem.
By the
Plantagenet
The House of Plantagenet () was a royal house which originated from the lands of Anjou in France. The family held the English throne from 1154 (with the accession of Henry II at the end of the Anarchy) to 1485, when Richard III died in ...
era, the
English Crown had long-standing links with Italian financiers and merchants such as
Ricciardi of Lucca in Tuscany. These trade links were based on loans, similar to modern-day
Bank loan
In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that de ...
s; other loans were linked to the need to finance the
Crusades
The Crusades were a series of religious wars initiated, supported, and sometimes directed by the Latin Church in the medieval period. The best known of these Crusades are those to the Holy Land in the period between 1095 and 1291 that were ...
and the city-states of Italy found themselves - uniquely - at the intersection of international trade, finance and religion. The loans of the time were however not yet securitized in the form of bonds. That innovation came from further north:
Venice
Venice ( ; it, Venezia ; vec, Venesia or ) is a city in northeastern Italy and the capital of the Veneto region. It is built on a group of 118 small islands that are separated by canals and linked by over 400 bridges. The isla ...
.
In 12th Century Venice, the city-state's government began issuing war-bonds known as ''prestiti'', perpetuities paying a fixed rate of 5% These were initially regarded with suspicion but the ability to buy and sell them became regarded as valuable. Securities of this late Medieval period were priced with techniques very similar to those used in modern-day
Quantitative finance
Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets.
In general, there exist two separate branches of finance that require ...
. The bond market had begun.
Following the
Hundred Years' War, monarchs of
England
England is a country that is part of the United Kingdom. It shares land borders with Wales to its west and Scotland to its north. The Irish Sea lies northwest and the Celtic Sea to the southwest. It is separated from continental Europe b ...
and
France
France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of overseas regions and territories in the Americas and the Atlantic, Pacific and Indian Oceans. Its metropolitan area ...
defaulted on very large debts to Venetian bankers causing a collapse of the system of
Lombard banking
Lombard banking was a mount of piety style of pawn shop in the Middle Ages, a type of banking that originated in prosperous Northern Italy, in a region called Lombardy during the Middle Ages. The term was sometimes used in a derogatory sense, and ...
in 1345. This economic set-back
hit every part of economic life - including clothing, food and hygiene - and during the ensuing
Black Death the European economy and bond market were depleted even further. Venice banned its bankers from trading government debt but the idea of debt as a tradable instrument and thus the bond market endured.
With their origins in antiquity, bonds are much older than the equity market which appeared with the first ever joint-stock corporation the
Dutch East India Company
The United East India Company ( nl, Verenigde Oostindische Compagnie, the VOC) was a chartered company established on the 20th March 1602 by the States General of the Netherlands amalgamating existing companies into the first joint-stock ...
in 1602 (although some scholars argue that something similar to the joint-stock corporation existed in Ancient Rome).
The first-ever Sovereign bond was issued in 1693 by the newly formed
Bank of England. This bond was used to fund conflict with
France
France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of overseas regions and territories in the Americas and the Atlantic, Pacific and Indian Oceans. Its metropolitan area ...
. Other European governments followed suit.
The U.S.A. first issued sovereign Treasury bonds to finance the
American Revolutionary War
The American Revolutionary War (April 19, 1775 – September 3, 1783), also known as the Revolutionary War or American War of Independence, was a major war of the American Revolution. Widely considered as the war that secured the independence of t ...
. Sovereign debt ("Liberty Bonds") was again used to finance its
World War I
World War I (28 July 1914 11 November 1918), often abbreviated as WWI, was one of the deadliest global conflicts in history. Belligerents included much of Europe, the Russian Empire, the United States, and the Ottoman Empire, with fightin ...
efforts and issued in 1917 shortly after the U.S. declared war on Germany.
Each maturity of bond (one-year, two-year, five-year and so on) was thought of as a separate market until the mid-1970s when traders at
Salomon Brothers
Salomon Brothers, Inc., was an American multinational bulge bracket investment bank headquartered in New York. It was one of the five largest investment banking enterprises in the United States and the most profitable firm on Wall Street durin ...
began
drawing a curve through their yields. This innovation - the
yield curve
In finance, the yield curve is a graph which depicts how the yields on debt instruments - such as bonds - vary as a function of their years remaining to maturity. Typically, the graph's horizontal or x-axis is a time line of months or ye ...
- transformed the way bonds were both priced and traded and paved the way for
quantitative finance
Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets.
In general, there exist two separate branches of finance that require ...
to flourish.
Starting in the late 1970s, non-investment grade public companies were allowed to issue corporate debt.
The next innovation was the advent of
Derivatives in the 1980s and onwards, which saw the creation of
Collateralized debt obligation
A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Le ...
s,
Residential mortgage-backed securities and the advent of the
Structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and ...
s industry.
See also
*
Bond
Bond or bonds may refer to:
Common meanings
* Bond (finance), a type of debt security
* Bail bond, a commercial third-party guarantor of surety bonds in the United States
* Chemical bond, the attraction of atoms, ions or molecules to form chemica ...
*
Bond market index
A bond index or bond market index is a method of measuring the investment performance and characteristics of the bond market. There are numerous indices of differing construction that are designed to measure the aggregate bond market and its vari ...
*
Bond valuation
Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a ...
*
Corporate bond
*
Deferred financing costs Deferred financing costs or debt issuance costs is an accounting concept meaning costs associated with issuing debt (loans and bonds), such as various fees and commissions paid to investment banks, law firms, auditors, regulators, and so on. Since t ...
*
Government bond
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
*
Interest rate risk
*
Primary market :''"Primary market" may also refer to a market in art valuation.''
The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the issuer, with the issuer being paid the proce ...
*
Secondary market
*
Bullet strategy In finance, a bullet strategy is followed by a trader investing in intermediate-duration bonds, but not in long- and short-duration bonds.
The bullet strategy is based on the acquisition of a number of different types of securities over an exten ...
*
Barbell strategy In finance, a barbell strategy is formed when a trader invests in long- and short-duration bonds, but does not invest in intermediate-duration bonds. This strategy is useful when interest rates are rising; as the short term maturities are rolled o ...
*
War Bond
War bonds (sometimes referred to as Victory bonds, particularly in propaganda) are debt securities issued by a government to finance military operations and other expenditure in times of war without raising taxes to an unpopular level. They are ...
Specific:
*
US Savings Bonds
*
Foreign exchange reserves of the People's Republic of China
The foreign exchange reserves of China are the state of foreign exchange reserves held by the People's Republic of China, comprising cash, bank deposits, bonds, and other financial assets denominated in currencies other than China's national ...
*
Bill H. Gross
References
{{Authority control
Fixed income
Financial markets
Foreign exchange market