Bond Market

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Definition of Bond Market:

A bond market is a financial market where bonds are traded. It is also referred to as a credit market. 

Detailed Explanation:

A government or company may issue a bond in the bond market when it wants to borrow money. Publicly traded companies issue bonds to finance a business expansion and to avoid giving up an ownership interest in the company (as they would if they had financed their expansion by issuing more stock). The disadvantage of issuing bonds is that bonds must be paid back with interest. The cash disbursement may hamper the growth of a rapidly growing company. Governments are unable to sell stock, so they issue bonds to avoid raising taxes. They may use the proceeds to finance a public need or repay an existing bond that is maturing. 

Governments or companies initially issue a bond in the primary market. The proceeds from the sale is the only time the issuer receives funds. Investors may sell the bond in the secondary market. Bond prices are inversely related to interest rates. If market rates rise during the term of bond, then the value of the bond will fall, conversely if rates decrease, the bond's value will increase. The attached video is a skit explaining bonds and why bond prices and interest rates are indirectly related.

More money is traded in the bond market than the stock market. According to the Securities Industry and Financial Markets Association the average daily trading volume in the bond market in 2018 equaled $817 trillion. This compares to $271 trillion traded on the New York Stock Exchange and NASDAQ. (2019 SIFMA Capital Markets Fact Book)

A bond market provides a bond with added liquidity by making it easier to sell. Bank loans cannot be purchased by small investors, therefore they are not very liquid. However, loans can be packaged and sold as bonds. For example, most residential loans are securitized, meaning they have been converted into a pool of mortgages that can be sold as bonds in a bond market. But few investors have the time or ability to measure the credit risk of a bond. Credit agencies such as Standard & Poor's, Fitch Ratings, and Moody's provide the vital service of rating bonds to provide an investor with an understanding of the credit risk. This also adds liquidity by increasing the number of interested investors. 

Dig Deeper With These Free Lessons:

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The Federal Budget and Managing The National Debt 

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