What is Bond Market ?
Financial markets are divided into the money and capital markets. In turn, the capital market consists of the equity and bond markets. As with all markets, the BM also has trade objects and participants, which analyze market data to provide transparency and monitor future trends. They show a specific market behavior, which is expressed by supply and demand. The core of the bond markets are the stock exchanges.
Bond Market Definition
It is a constituent part of the securities market where the medium- and long-term loans are made. It is characterized by instruments (notes, bills, and bonds), for which, the interest is paid for a fixed period. While also according to the terms of the loan, have a maturity between 1 and 30 years. In this case, a market is a set of relevant securities, individuals, and legal entities taking part in transactions with these securities and mechanisms that make these transactions possible.
The global bond market grew sharply in the 1980s and 1990s due to the expansion of the corporate bond segment. In 2005, it amounted to $31 trillion — this represented 98% of global gross domestic product. In the second quarter of 2016, global BMs reached a volume of USD 720.8 billion, followed by EUR 367 billion, AUD 19.1 billion, and JPY 7.9 billion.
The US government BM is the largest in the world. It is also one of the most reliable and liquid markets. Securities that have a maturity between 1 and 30 years circulate on this market. These securities are presented by treasury notes, bonds, bills, and TIPS (treasury inflation-protected securities). To finance the US budget deficit, the Treasury sells government bonds to institutional and private investors through public auctions. Auctions are held regularly according to a predetermined schedule. The auction consists of 3 stages: auction announcement, accepting applications for participation, and issuing securities.
Bond Market Participants
Issuers, investors (institutional or private), credit institutions, and stockbrokers participate in the BM. The trading motive of these participants may be investment, service (credit institutions with securities orders of their clients), arbitrage, or speculation. The market mechanisms create a price-based supply and demand. Typical market data are, in addition to the stock market price, the issue, and the current yield. Both are considered as interest, which is often used as a reference rate.
The debtor (issuer) receives temporary capital on the primary market from the creditors, in exchange for bonds. From the debtor's point of view, this capital represents debt capital. The issued securities can be resold in the secondary market. The trading volume of bonds on the international BM is significantly higher in nominal terms as compared to the stock market. The reasons for this are that government bonds are traded in the BMs, and companies hold the leverage ratio (which includes corporate bonds) at between 70% and 80%.
Bond Market Structure
The BM consists of 3 segments: short-, medium-, and long-term.
- The short term segment is represented by bills - securities that are traded for less than one year. Such bills are sold at a discount.
- The medium-term segment includes notes, the circulation period of which does not exceed 10 years.
- The long term segment is represented by bonds with maturities of 20 and 30 years.
Additionally, securities whose coupon rate is regularly indexed to the inflation rate in the country (TIPS) are also presented in this market.
Why Bond Markets Are Important
Bond markets cover - at least in part - the capital requirements for state and corporate debt because investors buy the bonds as creditors. Also, these markets provide an accurate distribution of company data and ratings for business valuation. The bond market also facilitates economic growth because the government and corporate finance are partly taken over by investors and co-finances these capacity expansions through the startup or expansion investments.
