Bond market

The bond market, also known as the debt, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. The size of the international bond market is an estimated $45 trillion and the size of outstanding U.S. bond market debt is $25.2 trillion.

Nearly all of the $923 billion Average Daily Trading Volume in the U.S. Bond Market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds, mainly corporate, are listed on exchanges.

References to the "bond market" usually refer to the government bond market because of its size, liquidity, lack of credit risk and therefore, sensitivity to interest rates. 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.

Market structure

Unlike the stock market, or markets for futures and options, bond markets in most countries remain decentralized and lack common exchanges. This has occurred, in part, because no two bond issues are exactly alike, and the number of different securities outstanding is far larger. In the United States, various banks act as market makers - though they are not obligated to buy or sell and may stop participation at any time.

Types of bond markets

The Bond Market Association classifies the broader bond market into five specific bond markets.

• Corporate
• Government & Agency
• Municipal
• Mortgage Backed, Asset Backed, and Collateralized Debt Obligation
• Funding

Bond market participants

Bond market participants are similar to participants in most financial markets and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.

Participants include:

• Institutional investors;
• Governments;
• Traders; and
• 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, approximately 10% of the market is currently held by private individuals.

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 (decrease), the value of existing bonds falls (rises), since new issues pay a higher (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.

Economist's consensus views of economic indicators 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.

Bond investments

Investment companies allow individual investors the ability to participate in the bond markets through bond funds, 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. 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.

See also

• Bond
• Government bond
• Corporate bond
• Interest rate risk
• Primary market
• Secondary market

External links

• Investing In Bonds Only: Why This Investment Strategy Doesn't Work... and What Does
• Investing in Bonds, an education site for bond investors
• The Bond Market Association
• ShibuiMarkets
• Bonds 101, bonds.yahoo.com
• Fixed-Income Funds
• USTreasuryMarket.com: Dealer misconduct, including front-running, in government bond market.