Tuesday, November 6, 2007

Bond market

The bond market (also known as the debt, credit, or fixed income market) is a financial market where

participants buy and sell debt securities usually in the form of bonds. The size of the international

bond market is an estimated $45 trillion of which the size of outstanding U.S. bond market debt is $25.2

trillion. [1]

Nearly all of the $923 billion average daily trading volume in the U.S. Bond Market [2] takes place

between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market.

However, a small number of bonds, mainly corporate, are listed on exchanges.

References to the "bond market" usually refer to the government bond market because of its size,

liquidity, lack of credit risk and therefore, sensitivity to interest rates. Because of the inverse

relationship between bond valuation and interest rates, the bond market is often used to indicate

changes in interest rates or the shape of the yield curve.

Market structure

Bond markets in most countries remain decentralized and lack common exchanges like stock, future and

commodity markets. This has occurred, in part, because no two bond issues are exactly alike, and the

number of different securities outstanding is far larger.

However, the New York Stock Exchange (NYSE) is the largest centralized bond market, representing mostly

corporate bonds. The NYSE migrated from the Automated Bond System (ABS) to the NYSE Bonds trading system

in April 2007 and expects the number of traded issues to increase from 1000 to 6000. [3]

Types of bond markets

The Securities Industry and Financial Markets Association classifies the broader bond market into five

specific bond markets.

* Corporate
* Government & Agency
* Municipal
* Mortgage Backed, Asset Backed, and Collateralized Debt Obligation
* Funding

Bond market participants

Bond market participants are similar to participants in most financial markets and are essentially

either buyers (debt issuer) of funds or sellers (institution) of funds and often both.

Participants include:

* Institutional investors;
* Governments;
* Traders; and
* Individuals

Because of the specificity of individual bond issues, and the lack of liquidity in many smaller issues,

the majority of outstanding bonds are held by institutions like pension funds, banks and mutual funds.

In the United States, approximately 10% of the market is currently held by private individuals.

Bond market volatility

For market participants who own a bond, collect the coupon and hold it to maturity, market volatility is

irrelevant; principal and interest are received according to a pre-determined schedule.

But participants who buy and sell bonds before maturity are exposed to many risks, most importantly

changes in interest rates. When interest rates increase (decrease), the value of existing bonds fall

(rise), since new issues pay a higher (lower) yield. This is the fundamental concept of bond market

volatility: changes in bond prices are inverse to changes in interest rates. Fluctuating interest rates

are part of a country's monetary policy and bond market volatility is a response to expected monetary

policy and economic changes.

Economist's consensus views of economic indicators versus actual released data contribute to market

volatility. A tight consensus is generally reflected in bond prices and there is little price movement

in the market after the release of "in-line" data. If the economic release differs from the consensus

view the market usually undergoes rapid price movement as participants interpret the data. Uncertainty

(as measured by a wide consensus) generally brings more volatility before and after an economic release.

Economic releases vary in importance and impact depending on where the economy is in the business cycle.

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