Bond Market

The bond market—also called the debt market, fixed-income market, or credit market—is where governments, municipalities, and corporations issue and trade debt securities to raise capital. Buyers of bonds lend money to issuers in exchange for periodic interest payments and return of principal at maturity.

Key takeaways

• Bonds finance government projects, corporate operations, and public works.
• Issuance occurs on the primary market; already-issued bonds trade on the secondary market.
• Bond types include government (Treasuries), municipal, corporate (investment grade and high-yield), mortgage-backed securities, and emerging-market bonds.
• Bonds are generally less volatile than stocks but carry credit and interest-rate risk.

A short history

Debt instruments have existed for millennia, with transferable loans recorded in ancient Mesopotamia. Sovereign borrowing expanded in the Middle Ages and modern era to fund wars and infrastructure; chartered corporations and early central banks also played key roles in developing tradable debt. Over time, government and corporate borrowing evolved into the global fixed-income markets we know today.

How the bond market works

• Primary market: Issuers sell newly created bonds directly to investors (public offerings or private placements).
• Secondary market: Investors buy and sell existing bonds through brokers, dealers, and electronic platforms. Many bonds are held within mutual funds, ETFs, pension funds, and insurance products.
• Pricing: Bond prices move inversely to interest rates. A bond’s sensitivity to rate changes is measured by duration. Credit ratings from agencies help assess default risk and influence yields.

Types of bonds

Government (sovereign) bonds

Issued by national governments and typically considered low-risk. In the U.S., Treasuries are the benchmark:
* T-bills: short-term (one year or less), sold at a discount.
* T-notes: maturities between 1 and 10 years, fixed interest.
* T-bonds: long-term, generally 20+ years.

Government bond risk can still change over time as fiscal conditions and ratings evolve.

Municipal bonds

Issued by states, cities, school districts, and other local entities to fund public projects. Many municipal bonds are federally tax-exempt and may be exempt from state or local taxes. Common structures:
* General obligation (GO) bonds: backed by issuer’s taxing power or general funds.
* Revenue bonds: repaid from project-specific revenues (e.g., tolls, utility fees).
* Conduit bonds: issued by a municipality on behalf of a third party.

Corporate bonds

Companies issue these to fund operations or growth. Categories:
* Investment grade: higher credit quality, lower default risk, lower yields.
* High-yield (junk) bonds: lower credit quality, higher yields to compensate for greater default risk.

Mortgage-backed and asset-backed securities (MBS/ABS)

Pools of mortgages or other loans are securitized and sold to investors. They provide regular cash flows from borrower payments but can carry prepayment and credit risks. MBS were central to the 2007–2010 subprime mortgage crisis, highlighting the importance of underwriting and structure.

Emerging-market bonds

Issued by governments or corporations in developing economies. They can offer higher yields and diversification but entail additional risks: political instability, currency fluctuations, weaker legal protections, and higher default probability. Historical programs (e.g., Brady bonds) helped restructure sovereign debt in past decades.

Bond indices

Benchmark indices (for example, the Bloomberg U.S. Aggregate Bond Index, the “Agg”) track performance of segments of the bond market. Indexes are used to evaluate funds and construct index-based ETFs that let investors access diversified fixed-income exposure.

Bond market vs. stock market

• Bonds = debt: issuer repays principal and interest; bondholders have priority over shareholders in bankruptcy.
• Stocks = equity: shareholders own part of the company and receive variable returns (dividends/price appreciation).
• Risk/return: bonds are typically less volatile with lower expected returns; stocks are generally riskier with higher potential gains.
• Sensitivities: bond prices are driven by interest rates and credit risk; stock prices reflect earnings, growth expectations, and investor sentiment.

Advantages and disadvantages

Pros:
* Generally less volatile than stocks.
* Regular income through interest payments.
* Wide variety of issuers and maturities for diversification.
* Senior claim on assets relative to equity in insolvency.

Cons:
* Lower long-term returns than equities.
* Interest-rate risk: rising rates reduce existing bond prices.
* Credit/default risk: issuer may miss interest or principal payments.
* Access: buying new-issue bonds can be less accessible for individual retail investors.

Common questions

Are bonds a good investment?
It depends on goals and risk tolerance. Bonds can preserve capital and provide income, but yield and risk vary widely by issuer and type.

Can investors lose money in bonds?
Yes. Bond prices fall when interest rates rise; credit events or defaults can cause significant losses. Duration and credit quality are key considerations.

How can retail investors access bonds?
Through bond-focused mutual funds, ETFs, or brokerage platforms that provide access to the secondary market. These vehicles offer diversification and liquidity for smaller investors.

Conclusion

The bond market is a core component of global finance, enabling governments and corporations to borrow while offering investors income and diversification. Understanding the different bond types, the impact of interest rates, and credit risk is essential for making informed fixed-income investment decisions.