Bond market
Encyclopedia
The bond 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
, usually in the form of bonds
. The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures. As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion, of which the size of the outstanding U.S. bond market debt was $31.2 trillion according to Bank for International Settlements
(BIS), or alternatively $35.2 trillion as of Q2 2011 according to Securities Industry and Financial Markets Association
(SIFMA).
Nearly all of the $822 billion average daily trading volume in the U.S. bond market takes place between broker-dealer
s and large institutions in a decentralized, over-the-counter
(OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges
.
References to the "bond market" usually refer to the government bond
market, because of its size, liquidity, relative lack of credit risk
and, therefore, sensitivity to interest rate
s. Because of the inverse relationship between bond valuation
and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve
. The yield curve is the measure of "cost of funding".
(SIFMA) classifies the broader bond market into five specific bond markets.
s and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.
Participants include:
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, banks and mutual funds. In the United States
, approximately 10% of the market is currently held by private individuals.
The outstanding value of international bonds increased by 3% in 2010 to $28 trillion. The $1.5 trillion issued during the year was down 35% on the 2009 total. The first quarter of 2011 was off to a strong start with issuance of nearly $500bn. The US was the leading centre in terms of value outstanding with 24% of the total followed by the UK 13%.
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, of some 14.4 trillion dollars at the time. This figure is likely to have excluded the inter-governmental debts such as those held by the Federal Reserve and the Social Security Trust.
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
and bond market volatility is a response to expected monetary policy and economic changes.
Economists' views of economic indicator
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 an economic release. Economic releases vary in importance and impact depending on where the economy is in the business cycle
.
s, closed-end fund
s 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. Exchange-traded fund
s (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.
or Russell Indexes
for stocks
. The most common American benchmarks are the Barclays Capital Aggregate Bond Index, Citigroup BIG and Merrill Lynch Domestic Master
. 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 and/or sector for managing specialized portfolios.
Specific:
Financial market
In economics, a financial market is a mechanism that allows people and entities to buy and sell financial securities , commodities , and other fungible items of value at low transaction costs and at prices that reflect supply and demand.Both general markets and...
where participants can issue new debt, known as the primary market
Primary market
The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process...
, or buy and sell debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
, known as the Secondary market
Secondary market
The page applies to the finanical term; For the merchandising concept, see Aftermarket .The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold....
, usually in the form of bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
. The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures. As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion, of which the size of the outstanding U.S. bond market debt was $31.2 trillion according to Bank for International Settlements
Bank for International Settlements
The Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...
(BIS), or alternatively $35.2 trillion as of Q2 2011 according to Securities Industry and Financial Markets Association
Securities Industry and Financial Markets Association
The Securities Industry and Financial Markets Association is a leading securities industry trade group representing securities firms, banks, and asset management companies in the U.S. and Hong Kong. SIFMA was formed on November 1, 2006, from the merger of The Bond Market Association and the...
(SIFMA).
Nearly all of the $822 billion average daily trading volume in the U.S. bond market takes place between broker-dealer
Broker-dealer
A broker-dealer is a term used in United States financial services regulations. It is a natural person, a company or other organization that trades securities for its own account or on behalf of its customers....
s and large institutions in a decentralized, over-the-counter
Over-the-counter (finance)
Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....
(OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...
.
References to the "bond market" usually refer to the government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
market, because of its size, liquidity, relative lack of credit risk
Credit risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....
and, therefore, sensitivity to interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
s. Because of the inverse relationship between bond valuation
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 bond is obtained by discounting the bond's expected...
and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve
Yield curve
In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
. The yield curve is the measure of "cost of funding".
Types of bond markets
The Securities Industry and Financial Markets AssociationSecurities Industry and Financial Markets Association
The Securities Industry and Financial Markets Association is a leading securities industry trade group representing securities firms, banks, and asset management companies in the U.S. and Hong Kong. SIFMA was formed on November 1, 2006, from the merger of The Bond Market Association and the...
(SIFMA) classifies the broader bond market into five specific bond markets.
- CorporateCorporate bondA corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...
- Government & agency
- MunicipalMunicipal bondA municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds includes cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any...
- Mortgage backed, asset backed, and collateralized debt obligationCollateralized debt obligationCollateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...
- Funding
Bond market participants
Bond market participants are similar to participants in most financial marketFinancial market
In economics, a financial market is a mechanism that allows people and entities to buy and sell financial securities , commodities , and other fungible items of value at low transaction costs and at prices that reflect supply and demand.Both general markets and...
s and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.
Participants include:
- Institutional investorInstitutional investorInstitutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets...
s - Governments
- TradersTrader (finance)A trader is someone in finance who buys and sells financial instruments such as stocks, bonds, commodities and derivatives. A broker who simply fills buy or sell orders is not a trader, as they are merely executing instructions given to them. According to the Wall Street Journal in 2004, a managing...
- 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, banks and mutual funds. In the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, approximately 10% of the market is currently held by private individuals.
Bond market size
Amounts outstanding on the global bond market increased by 5% in 2010 to a record $95 trillion. Domestic bonds accounted for 70% of the total and international bonds for the remainder. The US was the largest market with 39% of the total followed by Japan (20%). As a proportion of global GDP, the bond market increased to 130% in 2010 from 119% in 2008 and 80% a decade earlier. The considerable growth means that at the end of 2010 it was much larger than the global equity market which had a market capitalisation of around $55 trillion. Growth of the market since the start of the economic slowdown was largely a result of an increase in issuance by governments, with government bonds accounting for 43% of the value outstanding at the end of 2010, up from 39% a year earlier.The outstanding value of international bonds increased by 3% in 2010 to $28 trillion. The $1.5 trillion issued during the year was down 35% on the 2009 total. The first quarter of 2011 was off to a strong start with issuance of nearly $500bn. The US was the leading centre in terms of value outstanding with 24% of the total followed by the UK 13%.
U.S. bond market size
According to the Securities Industry and Financial Markets Association (SIFMA), as of Q2 2011, the U. S. bond market size is (in trillions of dollars)| Category | Amount | Percentage |
|---|---|---|
| Government | 9.2 | 28 |
| Municipal | 2.9 | 9 |
| Agency | 2.4 | 7 |
| Corporate | 7.7 | 24 |
| Mortgage related | 8.3 | 26 |
| Asset Backed | 1.9 | 6 |
| Total | 32.3 | 100 |
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, of some 14.4 trillion dollars at the time. This figure is likely to have excluded the inter-governmental debts such as those held by the Federal Reserve and the Social Security Trust.
Bond market volatility
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
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
and bond market volatility is a response to expected monetary policy and economic changes.
Economists' views of economic indicator
Economic indicator
An economic indicator is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance. One application of economic indicators is the study of business cycles....
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 an economic release. Economic releases vary in importance and impact depending on where the economy is in the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
.
Bond market influence
Bond markets determine the price in terms of yield that a borrower must pay in able to receive funding. In one notable instance, when President Clinton attempted to increase the US budget deficit in the 1990s, it led to such a sell-off (decreasing prices; increasing yields) that he was forced to abandon the strategy and instead balance the budget.Bond investments
Investment companies allow individual investors the ability to participate in the bond markets through bond fundBond fund
A bond fund is a collective investment scheme that invests in bonds and other debt securities. Bond funds typically pay periodic dividends that include interest payments on the fund's underlying securities plus periodic realized capital appreciation. Bond funds typically pay higher dividends than...
s, closed-end fund
Closed-end fund
A closed-end fund is a collective investment scheme with a limited number of shares. It is called a closed-end fund because new shares are rarely issued once the fund has launched, and because shares are not normally redeemable for cash or securities until the fund liquidates.Typically an...
s and unit-investment trusts
Unit Investment Trust
A Unit Investment Trust is a US investment company offering a fixed portfolio of securities having a definite life. UITs are assembled by a sponsor and sold through brokers to investors.-Types:...
. In 2006 total bond fund net inflows increased 97% from $30.8 billion in 2005 to $60.8 billion in 2006. Exchange-traded fund
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s (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 500S&P 500
The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500 are those of large publicly held companies that trade on either of the two largest American stock...
or Russell Indexes
Russell Indexes
The Russell Indexes are a family of global equity indices that allow investors to track the performance of distinct market segments worldwide. Many investors use mutual funds or exchange-traded funds based on the Russell Indexes as a way of gaining exposure to certain portions of the U.S. stock...
for stocks
Stocks
Stocks are devices used in the medieval and colonial American times as a form of physical punishment involving public humiliation. The stocks partially immobilized its victims and they were often exposed in a public place such as the site of a market to the scorn of those who passed by...
. The most common American benchmarks are the Barclays Capital Aggregate Bond Index, Citigroup BIG and Merrill Lynch Domestic Master
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 Lehman U.S. Aggregate . The Domestic Master Index was created on December 31, 1975...
. 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 and/or sector for managing specialized portfolios.
See also
- BondBond (finance)In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
- Bond market indexBond market indexA bond market index is a composite listing of bonds or fixed income instruments and a statistic reflecting the composite value of its components...
- Bond valuationBond valuationBond 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 bond is obtained by discounting the bond's expected...
- Corporate bondCorporate bondA corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...
- Deferred financing costs
- Government bondGovernment bondA government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
- Interest rate riskInterest rate riskInterest rate risk is the risk borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa...
- Primary marketPrimary marketThe primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process...
- Secondary marketSecondary marketThe page applies to the finanical term; For the merchandising concept, see Aftermarket .The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold....
- Bullet strategyBullet strategyIn finance, a bullet strategy is formed when a trader invests in intermediate duration bonds, but does not invest in the Long and Short duration bonds....
- Barbell strategyBarbell strategyIn finance, a Barbell strategy is formed when a Trader invests in Long and Short duration bonds, but does not invest in the intermediate duration bonds....
- War BondWar bondWar bonds are debt securities issued by a government for the purpose of financing military operations during times of war. War bonds generate capital for the government and make civilians feel involved in their national militaries...
Specific:
- US Savings Bonds
- Foreign exchange reserves of the People's Republic of China