What Is Bond Market?

by : sayush

A bond is a debt obligation or security, where the the holder or buyer expects the holder to repay the principal and interest at maturity (a date in the future). The bond market is a financial market where these bonds are bought and sold. To get an estimate of the size of these debt securities markets you should bear in mind that the international bond market is approximately $45 trillion and the size of U.S. bond market debt is about $25.2 trillion.

How are these markets structured?

Quite different from the stock, futures and options markets, most of the trading volume in bond markets takes place between brokers and large financial institutions in an over-the-counter market. But, a couple of bonds, primarily corporate ones, are listed on exchanges. This is partly due to the differences in bonds.

What are the various types of bond markets?

The Securities Industry and Financial Markets Association(SIFMA) classifies the bond market into the following categories:

1) Corporate

In simple terms, corporate debt securities are IOU's issued by corporations so that they can use this cash to support their day-to-day operations and generate greater profits in the future. All sorts of corporations issue corportate debt. These could range from industrial, financial companies to service-related ones.

2) Government and Agency

As the name suggests, government and agency debt is issued by different government-sponsored enterprises (GSEs). These entities have been created by Congress to fund loans at affordable rates to certain kinds of borrowers (such as students, farmers and homeowners). GSEs mostly rely on debt financing for their daily operations. Some examples of GSEs in this regard - Fannie Mae, Sallie Mae, Federal Farm Credit System Banks etc.

3) Municipal

Municipal securities are debt securities issued by counties, cities, states, and other governmental entities to raise money to build/maintain infrastructure such as highways, schools, hospitals, and drainage systems. This is perhaps the the state and local governments in the United States finance their cash flow requirements. One great appeal of investing in municipal bonds is that the interest on these securities is exempt from the federal income taxes.

4) Mortgage Backed Securities and Asset-Backed Securities

Financial institutions issue mortgage debt securities to those interested in ownership of mortgage loans. These are loans that are used to finance the borrower's purchase of homes or other real estate. As the underlying loans (mortgages) are being paid off, the investors receive interest payments in addition to their principal being paid off.

Some examples of agencies that issue these debt securities are - Ginnie Mae (Government National Mortgage Association), Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).

Asset-backed securities (ABS) are similar in mortgage securities in that they represent an interest in a variety of assets such as auto loans, auto leases, home equity loans, or credit card receivables. The investors in these debt securities receive interest payments in addition to their principal as the underlying loan is being paid off.

In summary, you have learnt what bond markets are, the different types of bond markets and the different players in these markets.