BOND MARKET A financial marketplace where debt instruments, primarily bonds, are bought and sold is called a bond

market. The dealings in a bond market are limited to a small group of participants. Contrary to stock or commodities trading, the bond market (also known as the debt market) lacks a central exchange.

Players in a Bond Market

The bond market involves transactions among three key players: Issuers: They comprise of organizations and other entities that sell bonds to raise funds to finance their operations. These include banks, both local and multinational, as well as the government as an issuing entity. Underwriters: This segment consists mainly of investment banks and institutions that are leaders in the investing business. They help the issuer to raise funds by selling bonds. Also, they perform the key role of middlemen and undertake crucial activities, such as preparing legal documents, prospectus and other collaterals to simplify transactions. Purchasers: This is the group that buys the debt instruments. In addition to the government and corporations, this section consists of individual investors who invest in the bond market through unit-investment trusts, close-ended funds and bond funds.

Types of Bond Markets

Based on the types of bonds in which they deal, the Securities Industry and Financial Markets Association has categorized the bond market into five types. These are: Corporate: includes trading in debt securities issued by corporations and industries to raise funds. Government and Agency: involves trading in bonds issued by government departments as well as enterprises sponsored by the government or agencies backed by it. Municipal: covers transactions in municipal securities issued by states, districts and counties. Mortgage Backed Securities: includes dealings in asset-backed securities that are protected by mortgages.

Risk Factors in a Credit Market

Although dealings in the fixed-income market might be lucrative, an investor must be aware that these are prone to variations in interest rates. When the market-based interest rate rises, there is a decline in the value of existing bonds. This is on account of the issuance of new bonds at a higher interest rate. In order to limit your exposure to losses arising from escalations in the interest rate, it is advisable to hold a bond till maturity.

BOND RATES Bond rates are the predetermined interest rates paid by the issuer of a bond, note or any other fixed income security. Also known as coupon rates, bond rates are expressed as a percentage of the face value or principal, on an annualized basis. For example, if a $100 bond pays an annual interest of $7, its bond rate or coupon rate is 7%. The payments can be monthly, quarterly, semi-annually or annually, depending on the terms of the bond. However, there are certain bonds, like the zero coupon bonds, that do not make interest payments. They are sold at a price lower than their face value and the bondholder earns from capital appreciation alone. Capital appreciation is the difference between the amount an investor pays for purchasing the bond and the actual par value of the bond, which the investor receives at maturity. How Bond Rates are Determined The bond rate depends primarily upon four factors: Type of bonds: Bond rates depend on bond categories, such as zero-coupon, convertible and income bonds. Interest rate: The bond rate is highly sensitive to changes in interest rates. Bonds issued by the government offer coupon rates that reflect the interest rate announced by a nations central bank. Competition ensures that bonds issued by companies or other organizations offer similar coupon rates. Date of maturity: The farther is the date of maturity (redemption date) from the issue date, the higher would be the coupon rate. Thus, a five-year bond would typically offer a lower coupon rate than a ten-year bond. Bond ratings: Credit rating agencies, such as Standard & Poor's and Moody's, assess the risk of certain bonds and issue grades that reflect the issuers ability to make interest payments and repay the principal at maturity. Bonds with higher ratings offer lower coupon rates, since they represent lower risk than bonds with lower credit ratings. Beyond Bond Rates The bond yield, or the total earnings from a bond, is dependent not only on the bond rate, but also on the capital appreciation (price of a bond). The bond price is determined by the market, taking into account: The principal or face value of the bond. The redemption date. The coupon rate. Credit rating of the issuer, which reflects the ability of the issuer to meet the promised principal and interest payments..

The yield offered by other similar bonds in the market.