What is the bond market?

The bond market is a place where people buy and sell bonds. Bonds are a type of investment. When you buy a bond, you are lending money to a company or government. They promise to pay you back the money you lent them plus interest.

There are different kinds of bonds:

• Government bonds: Bonds issued by a country’s government
• Municipal bonds: Bonds issued by cities, states, or other local governments
• Corporate bonds: Bonds issued by companies
• Convertible bonds: Special corporate bonds that can be converted into stock

The bond market is very important. It helps companies and governments borrow the money they need to do things. It also gives investors a way to make money by lending.

How big is the bond market?

The bond market is huge! It’s one of the biggest financial markets in the world. Every day, trillions of dollars worth of bonds are bought and sold.

The US bond market is the biggest. It has over $40 trillion of bonds. Other countries with big bond markets include Japan, China, the UK, and Germany.

Key parts of the bond market

Each country’s bond market is a little different. But they all have buyers, sellers, and people in the middle who help the market work smoothly.

The buyers are investors who want to lend money to earn interest. They include:

• Individual people
• Banks
• Mutual funds and ETFs
• Insurance companies
• Pension funds
• Foreign governments

The sellers are the borrowers. They issue new bonds to get money. The main bond issuers are:

• Governments and government agencies
• States and cities
• Large corporations

In between the buyers and sellers are dealers and brokers. They help buyers and sellers find each other. They make the market more liquid. That means it’s easier to quickly buy and sell bonds at a fair price.

How does the bond market work?

When a government or company needs to borrow money, they issue new bonds. This is called the primary market. The borrower hires investment banks to help them issue the bonds.

The banks buy the new bonds from the issuer. Then they resell them to investors in the secondary market. That’s where most bond trading happens.

Primary market

In the primary market, the borrower and the banks agree on the key terms of the new bonds:

• Amount to borrow
• Interest rate
• When the bonds mature (are paid back)
• Other special features

Then the banks market the new bonds to investors. They want to sell all of the bonds at the best price. When investors buy the new bonds, the borrower gets the money.

Secondary market

The secondary market is where investors buy and sell bonds after they are issued. Most bonds trade “over the counter.” Investors don’t meet in person at an exchange. Instead, bond dealers help buyers and sellers find each other. They are the “market makers.”

An investor who wants to buy or sell a bond contacts dealers for price quotes. The dealers compete to offer the best prices. When the investor finds a good price, they do the trade with that dealer. Then the dealer turns around and tries to buy or sell that same bond with a different investor. They want to quickly match buyers and sellers so they don’t have to hold the bonds themselves.

This constant buying and selling by dealers and investors makes the bond market liquid. Investors can usually sell their bonds quickly if they need the money for something else. And they can reinvest money into new bonds whenever they want.

Bond prices and yields

Bond prices and yields are always changing. Yield measures how much an investor earns on a bond. It depends on the bond’s interest rate and price.

When bond prices go up, yields go down. And when prices go down, yields go up. Yields and prices move in opposite directions.

What makes bond prices change?

Bond prices change for a few main reasons:

1. Interest rates: When interest rates rise, new bonds pay higher yields than older bonds. So the prices of older bonds go down. The opposite happens when interest rates fall.
2. Inflation: Bonds pay a fixed amount of interest. When inflation goes up, that money buys less. So bond prices fall.
3. Economic growth: In good economic times, investors prefer stocks and riskier investments. They sell bonds, so prices go down and yields go up. In bad times, investors want the safety of bonds. They buy bonds, so prices go up and yields fall.
4. Time to maturity: Bonds that mature farther in the future have more risk. Their prices are more sensitive to interest rate changes.
5. Credit risk: Some issuers are more likely to default than others. Riskier bonds have lower prices and higher yields.

Following the bond market

Investors and experts track the bond market very closely. They watch things like:

• Treasury bond yields, especially the 10-year Treasury note
• The “yield curve” comparing yields on bonds with different maturities
• Yield “spreads” between Treasury bonds and riskier bonds
• Bond market indexes that track prices

Changes in the bond market affect everyone. Bond yields influence other important interest rates in the economy. Mortgage rates, car loan rates, and corporate borrowing costs depend on bond yields.

The bond market also signals what investors think about the economy. A strong economy tends to have rising interest rates and a steep yield curve. A weak economy tends to have falling rates and a flat or inverted yield curve. Investors buy and sell bonds based on their economic outlook.