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.
