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Bond Market: Meaning, Types, Strategies, Bond Indices and More

Bond Market: Meaning

Bond Market is a market place where purchasing and selling of debt securities like bonds, takes place. It is one of the major sources of finance for both government and corporates. These bonds carry fixed interest payments and also have a fixed maturity date. Bond Market is a platform for raising funds from the general public at a large. It is like lending by the investors to the Companies, Central Government, and Municipalities in exchange for fixed interest incomes. Only companies can issue Equity Shares, while both the government and companies can issue bonds to the public at large. There are many other names for this market like Fixed-Income Securities Market, Debt Market, and Credit Market.

Who Issues Bonds?

The government uses this market for doing fundraising to finance the routine government expenditure, arranging funds for public welfare schemes and projects, and paying off the debt. The focus here is mostly on infrastructural projects, which require huge amounts of funds at a comparatively cheaper rate from the public. Bonds are a lesser expensive source of finance than loans from the Banks or financial institutions. Therefore, Bond Market sees a lot of issuance happening regularly from both the central and state governments, autonomous bodies like municipalities and corporates.

Public and Private Companies use this market for raising debt funds to finance their working capital requirements or arranging funds for any new/existing project. There could also be other miscellaneous reasons, but these are major reasons. Even companies prefer this market because this source of finance is cheaper than Equity (Though not always, depending on the situation) or Loans. Moreover, in the case of Equity, there is a requirement for a lot of public disclosure.

As a result, both Companies and governments prefer Bond Market.

Why Investors Invest in Bond Market?

Investors also prefer investing in this market because the bond gives a fixed guaranteed return. Government Bonds weigh higher than the Companies Bonds, as they are more secured in nature. The general public has more trust in governments than a corporate.

Primary Bond Market Vs Secondary Bond Market

The Bond Market functions in two different markets, i.e. Primary Market and Secondary Market. In the Primary Market, first-time issuance of bonds or for that matter that particular security takes place. In other words, all fresh or new issues of bonds offer to the public for subscription happens through the Primary Market. And the subscription, allotment, and distribution take place directly between the bond issuer and the bond subscriber/investor. Here there is no involvement of any intermediary, and bonds are out for issuance and listing for the first time in the market.

In the case of the Secondary Market, an intermediary plays an important role. Here the trading of bonds takes place in a decentralized way through an OTC (Over-the-counter) platform. In this market re-buying and re-selling of Bonds already issued and listed takes place. Investors buy already issued, listed, and traded Bonds from an intermediary in an open market. Moreover, this trade happens according to the current market rates and the original coupon rate.  Trading in these bonds can take place at a premium or discount. 

Types of Bond Market

Bonds Market have five major categorization. Each one of them is different from another, they are as follows:-

Corporate Bonds Market

When any private or public company issues bonds in this market, such bonds are usually referred to as corporate bonds. And such a market where the regular trade takes place is referred to as Corporate Bonds Market. Public companies can also issue convertible bonds, which can be later converted into equity shares as well. These Bonds are a long-term source of finance for the companies and will have a minimum maturity of 1 year.

Corporate Bonds are of two types, i.e. Investment Bonds and Junk Bonds. Investment ones are stable and less risky, while Junk ones are more of a speculative nature and are very risky. The idea for Junk Bonds is to get a killing at a dead low price, in case the fortunes of the company turn around. Or a merger or some association happens with a credible and resourceful investor or company.

Government Bonds Market

The Central government of the country also raises funds by issuing Government Bonds in Government Bond Market. It is also known as Treasury Market. The Central government of the country issues these fixed-income securities with a specific face value, maturity date, and all interest payments with the compounding effect as well. Investors have a major attraction of this security because of the trust with the government so it remains absolutely safe and secure. Moreover, the interest rates and payment frequency remains fixed.

TIPS (Treasury Inflation-Protected Securities) is a  type of government bond linking directly to the inflation prevailing in the economy of the country. This is a very popular type of government bond, as it provides real interest rates (nominal interest rate – inflation rate). 

Municipal Bonds Market

Issuance of Municipal Bonds takes place at a lower level like at state, city, district, or even lower to it. In this market, the issuance happens by the autonomous or government bodies at a comparatively lower level. The quantum is smaller than the Government Bonds Market, but still, most of the investors prefer it because of the safety and security of the money. Government bodies use funds raised in this market for sponsoring projects and working capital needs.

Mortgage-Backed Bonds Market

Generally, these types of bonds issue happen by Banks/Financial Institutions. With the help of this Mortgage-back security the Banks or Financial Institutions transfer/share the risk of the mortgage loans. Issuance of these bonds takes place by bundling those mortgage loans and converting it into a security. These are comparatively risky in nature but provide regular interest payments. The market where trading of Mortgage-back securities takes place is known as Mortgage-Backed Bonds Market.

Emerging Countries Bonds Market

Emerging Countries are developing countries, and they always remain the target for investment from developed countries, pension funds, and investment agencies. Because the interest rates usually are higher in these countries comparatively. Hence, for achieving or gaining higher returns the funds from developed countries find a way to emerging countries. The companies or countries that belong to Emerging Economies often issue these bonds and so government or corporate bonds can also become part of this. Though these bonds offer higher returns but also have the country specific political and geographical risks.

Bond Market

Bond Market Strategies

Investors use majorly three strategies for analyzing and investing in Bonds Market. They are as follows:-

Active Strategy

The first strategy is Active Strategy, where the sole target is to achieve higher returns over a longer-term. Hence, investors generally stay in for a longer duration and try to take advantage out of interest rate changes, shifting of the yield curve, and also variations due to the change in credit ratings. 

Passive Strategy

In the case of Passive Strategy, the investors prefer to keep the bonds until maturity. The aim or the target is to achieve reasonable returns consistently with utmost safety without indulging in regular trading. Here the idea is to match cash flows with the liabilities with the minimum cost.

Hybrid Strategy

As the name suggests it is a combination of both Active and Passive Strategies. It overcomes the limitations of both strategies. 

Bond Indices

As there are many indices in the Stock Exchange, tracking different components, there are also Bond Indices, tracking both the government and corporate bonds. These Indices continuously tracks the performance of these bonds and fluctuates accordingly.

Bond Market Vs Stock Market

Trading of Bonds takes place in a Bond Market, while trading of Stocks/Equities happens in Stock Market. When we talk about the extent and level of risk involved in trading, both the markets are exposed to a different set of risks. But the level and extent of risk are definitely higher in the Stock Market as compared to the Bond Market. Stock Market returns are unpredictable and quite volatile. Whereas Bond Market gives a fixed return, maturity dates are largely fixed and the fluctuations in return and price are very less. Government issue happens only in Bond Market and not in the Stock Market. 

These differences are non-exhaustive in nature.

Conclusion

Bond Market is a very important platform for both investors and bond issuers. It has its own mechanism of rendering fixed returns to the investors. In the case of government and companies, it acts as a source of finance which is comparatively cheaper than other sources. But as we all know, this instrument can render all benefits to the companies only if credit ratings, companies reputations, and usage of funds are made clear before the issuance of Bonds. The Government should also justify the disposal of funds before the issuance. 

Last updated on : October 29th, 2020
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