A bond market is a financial market in which the people using the market buy and sell debt securities, most often in the form of financial bonds. Those who participate in trading on the bond market are the same types of individuals and institutions who participate in the general financial markets and include institutional investors, traders, individuals and governments. The majority of bonds in any of the world bond markets is held by institutional type investors such as banks, mutual funds and pension funds. For instance, only 10% of the bond market in the United States is held by individual investors. All bond market participants are either sellers, or institutions backing funds, of bonds and buyers, or debt issuers, of bonds.
Types of Bond Markets
There are five specific bond markets that are recognised by the SIFMA, or the Securities Industry and Financial Markets Association. The five types of bond markets include the corporate market, the government and agency market, the municipal market, the mortgage or asset backed market and the funding market. The corporate bond market trades in certificates issued by corporation in order to raise funds and expand business. In most cases, corporate bonds have a maturity date at least one year after the issuance date. The municipal bond market deals in certificates that are issued by any government entity below the level of a state or territory. Municipal generally refers to such entities as school districts, cities, counties and utility interests, as long as the agency is considered below the level of a state or territory.
Trading in the Bond Market
Those investors who purchase a bond with the intention of retaining the certificate until the maturity date and then collect on the bond on or after the maturity date, there is no affect of market volatility on that bond. Bonds are sold with a specific interest attached and a predetermined maturity date to be paid in full at that time. It is the investor who buys and sells bonds prior to the maturity date that is exposed to the volatility of the market and sees the greatest investment risk. Bond investors are able to gauge the volatility of the market by the increase or decrease of the interest rate that affects a specific type of market. The value of a bond, prior to the maturity date, follows directly opposite of the interest rate. Rising interest rates will devalue a bond, where falling interest rates can significantly increase the value of a bond.
Investment companies generally allow individual investors to participate in the bond market through unit-investment trusts, bond funds or closed-end funds. Exchange traded funds are another alternative for individuals looking to invest into the bond market. These are investments that are low cost, tax efficient and trade much in the same way as standard stocks. Exchange traded bonds are usually at their best, regarding return on investment value, during recessions. This is generally due to the fact investors leave the more volatile standard stock market in favor of the more stable bond market. Higher numbers of investors in the bond exchange traded fund market are usually a good indicator of a slow world economy.
Reading the Bond Market
The bond market index is a combined listing of bonds, or fixed income instruments, which provides a statistical number reflecting the value of the bonds in the index. It is a handy tool for the portfolio management professionals to analyze the financial stability of the securities backing the bonds. Bond indices can be composed in several configurations including, characteristics of the included bonds and the maturity date or credit rating. Bond indices themselves are normally utilized to look at the long-term performance of a particular bond market. The seven main bond market indices are listed below:
- Barclays Capital Aggregate Bond Index – for global bonds
- Lehman U.S. Aggregate – for U.S. based bonds
- Salomon BIG – for U.S. based bonds
- Merrill Lynch Domestic Master – for U.S. based bonds
- Capital Markets Bond Index (CPMKTB) – for U.S. based bonds
- Solomon Smith Barney World Government Bond Index – for government bonds
- J.P. Morgan Government Bond Index
- Access Bank Nigerian Government Bond Index
- FTSE UK Gilts Index Series – for government bonds
- MAX Hungarian Government Bond Index Series
- J.P. Morgan Emerging Markets Bond Index
- CSFB High-Yield II Index – for high-yield bonds
- Merrill Lynch High Yield Master – for high-yield bonds
- Bear Sterns High Yield Index (BSIX)
- S&P Leveraged Loan Index
- ABX:HE – for asset-backed securities bonds
Investors and portfolio managers can utilize any one of the listed bond indexes to determine which market, and which bonds, to invest into. While some investors only have the capital to invest in one particular type of “safe” market, some investors choose to diversify their portfolio with nominal investments into each type of bond or security available. Either strategy will depend on the long-term investment goals in place and the amount of capital available to invest.