Bond Market

A financial market facilitates the connection between fund seekers and investors. Mainly, there are four types of financial markets: Stock market, bond market, derivatives market, and currency market. This article sheds light on the bond market meaning, types of the bond market, the concept of bonds, and the basic things investors should consider before getting into the bond market.

Bonds are the financial securities that let the issuer borrow money from the investor for a specific tenure. The issuer compensates the lenders with coupon payments, at regular intervals till maturity, and repays the principal at maturity. By investing in bonds, investors can reap the benefit of regular interest income and ensure the safety of capital invested.

Generally, bonds are issued by governments, municipalities, and big corporations to meet their funding requirements. The prominent features of bonds are face value, coupon payments, maturity, yield, and ratings. The bonds are traded in the secondary market at a premium or discount post-issuance.

For example, a state government issues 5-years fixed-coupon bonds in the year 2022, with a face value of Rs. 1000, offering a 7% coupon rate. Ram purchases a bond. He will get Rs. 70 as a coupon payment, every year till 2027. In 2027, the government will pay back Rs. 1000. In case, he requires the money he can sell the bond in the secondary market at a prevailing price, which can be above or below Rs. 1000.

The bond market is where new debt securities are issued and traded. The bond market can be subdivided into two types - Primary market and secondary market. The primary market is where fresh-new debt securities are issued and the investors directly purchase those securities from them. Post the issuance, the existing debt securities are traded among the investors in the secondary market. Other popular names for the bond market are the credit market, the debt market, and the fixed-income market.

Bonds are essentially loans, extended to corporations and governments. Interest payments on bonds remain the same for the life of the loan. You receive the principal amount at the end of the term, assuming there are no defaults.

The value of a bond changes over time. This is only important if you are considering selling in the secondary market. Bond returns, also called ‘yields’ are compared against other bonds — low yielding bonds or low S&P ratings are not as valuable as high yield bonds.

The bond market is larger than the stock market by size. In 2021, the bond market size is estimated to be at $119 trillion, as compared to the $117 trillion equity market cap globally.

The bond market in India

Though the stock market is more popular, the bond market is gradually replacing the equity market for Indian investors. Additionally, the bond market is improving with some major reforms. RBI established the delivery versus payment system to ensure the smooth functioning of the delivery and payment of securities. Moreover, some unique and sophisticated bond products, such as capital indexed bonds, inflation-indexed bonds, and zero-coupon bonds, are traded in India.

Types of Bond market

Following are the main types of bond markets:

Corporate bond market: The market for the bond issued by corporations is termed the corporate bond market. They issue the bonds for their working capital requirements or for expanding the business. This market offers relatively higher returns due to higher risk.

Municipal bond market: The marketplace where the bonds issued by states, cities, municipalities, etc., are traded is referred to as the municipal bond market. Investors investing in this bond market can reap huge tax benefits.

Government bond market: The government raises funds by issuing bonds in the bond market. These bonds are considered highly safe as the government backs them. Though, the returns of these bonds are lower compared to other bonds.

Emerging market bond: This type of bond market is for bonds issued by governments and companies in emerging economies. These bonds offer higher returns with a considerable amount of risk. The additional risk involved in emerging market bonds is exchange rate risk.

Mortgage-backed and collateral debt obligation bond market: The market particularly relevant to the bonds collateralized by a mortgage or mortgages is termed the mortgage-backed bond market. Investors get the right to the value of the mortgage.

Basic things to know about Bond Market

Though investing in the bond market is relatively less risky, investors should be aware of the following:

If the issuer defaults, the bondholders get preference over shareholders for interest payment and principal repayment.

When bonds are among the safe-haven assets, the returns offered by them are lower than equity and other risky investments. Additionally, bonds are not entirely risk-free.

Two main risks involved in the bonds are credit risk and interest rate risk. If the issuer defaults and is unable to pay coupons or repay the principal on maturity, the investor can lose money. Additionally, if the prevailing market rates exceed the coupon rate of the bond, the prices of the bond decrease.

Another important factor to consider is liquidity. Usually, bonds have large tenure. Investors get the full principal at the end of this large tenure. Though they are traded in the secondary market, exiting the bonds before maturity may expose the investors to the volatility of the market.

To wrap up, the bond market is the financial market for the issuance and trading of bonds. This financial market is larger than the stock market. Investors have a plethora of choices to choose from while investing in this market. Similar to other markets, it has its own benefits and loopholes. It ensures lower risk but the liquidity and returns are also lower.

Relationship between stocks and bonds:

Bonds affect the stock market because stock prices tend to rise as bonds fall, and vice versa. Bonds compete with stocks for the investor's dollar, as bonds are often considered safer than stocks. However, bonds usually have lower yields.

When the economy is booming, shares tend to work out better. As consumers buy more, demand increases, meaning higher profits for businesses and confidence for investors. A great way to overcome inflation is to sell bonds and buy stocks when the economy is booming. When the economy slows, consumer purchases fall, corporate profits fall, and stock prices fall. In that case, investors prefer to pay the usual interest guaranteed by bonds.

As a result of too much liquidity chasing very few investments, the value of both — stocks and bonds — can rise at the same time. This can happen if some investors are optimistic and others pessimistic.

Both stocks and bonds can also fall. This is usually the case when an investor panics and sells his investment.

Bonds or stocks:

Deciding which a better investment is for you depend on two things:

Personal goals:Bonds are a good choice if you want to avoid losing capital and receive regular interest payments, and inflation is not a cause of worry. If you retire, or if you need to use capital gains, they may even be preferable.
If you can hold your stock when the price goes down, you don't need running income, and you want to overcome inflation, stocks are the better option.

Economy status: In the context of economic activity, business cycles are the ‘ups and downs’, defined in terms of periods of expansion or recession. The stock of a business in the expansion phase offers more profit. The stock value increases as the business’ earnings increase. On the other hand, bonds are better investments when it is receding. They protect your investment while providing income.

Irrespective of how bonds affect the stock market, the right option for you depends on your financial goals, but it is wise to have a diverse portfolio that combines both.

Explore bonds with us:

1. Corporate bonds
2. Capital gain bonds
3. Tax free bonds