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4.4. Bond market

As we have seen, the bond market is part of the LTDM. It is in this market that prices (interest rates) for long-term fixed-interest debt are discovered. The other part of the market, long-term floating-rate NMD (such as floating-rate mortgages), is benchmarked on money market rates (the prime lending rate of banks in this example).

Formally, we define the bond market as:

The bond market is the mechanism / conventions that exist for the issue of, investing in, and the trading of instruments that represent the long-term undertakings (usually of a fixed capital nature) of the issuers.

Long-term bonds are issued to fund long-term undertakings, such as roads, energy and water delivery infrastructure and factories. Not all long-term borrowers are able to issue bonds. It is the domain (mainly) of government and the rates on government bonds are regarded as risk-free (actually credit risk-free because market risk is intrinsic to bonds). The rates on all non-government (i.e. corporate) bonds are benchmarked on the government bond rates.

It is only the large companies that are able to issue bonds, and their bonds are required to be rated by one or more rating agencies before any investor will consider them. In addition to these bonds there are also bonds that are the products of securitization, such as the bonds of non-bank mortgage lenders, and others such as Collateralized Debt Obligations (CDOs). As these bonds are issued by Special Purpose Vehicles (SPVs) created for this purpose, we refer to them as SPV bonds. They also need to be rated before investors will consider them.

Many countries also allow the inward listing of bonds. By this is meant that foreign entities are permitted to issue bonds in the local market. They are called foreign bonds. Generally, it is foreign banks and other foreign government entities (including central governments) that are able to issue locally. Foreign bonds are also rated.

In summary, there are five broad classes of issuers in the bond market:

• Government sector (up to three levels).

• Public enterprises (also called parastatals).

• Corporate entities.

• Special purpose vehicles (SPVs).

• Foreign sector entities (inward listings).

The issuers of bonds / bond market may be depicted as in Figure 3.

bond market

Figure 3: bond market

There are many types of bonds in the bond markets of the world:

• Plain vanilla bonds.

• Bearer bonds versus registered bonds.

• Perpetual bonds versus fixed term bonds.

• Floating rate bonds versus fixed rate bonds.

• CPI bonds.

• Zero coupon bonds versus coupon bonds.

• Call bonds.

• STRIPS.

• Convertible bonds.

• Exchangeable bonds.

• Bonds with share warrants attached.

• General obligation bonds.

• Revenue bonds.

• Serial bonds.

• Catastrophe bonds.

• Asset-backed bonds.

• Senior, subordinated, junior and mezzanine bonds.

• Junk bonds.

• Guaranteed bonds.

• Pay-in-kind bonds.

• Split coupon bonds.

• Extendable bonds.

• Islamic bonds.

• Foreign bonds.

• Eurobonds.

• Global bonds.

• Retail bonds

• Islamic bonds.

The common bond is the first-mentioned, the plain vanilla bond; it has a fixed-term and a fixed coupon rate. Its only variable is its market rate.

The bond markets of the world tend to be formalized, i.e. bonds are listed on an exchange. However, there are some which are of the over-the-counter (OTC) variety.

The money and bond markets together are generally termed (apart from debt market) the fixed-interest market (because the majority of instruments carry fixed rates of interest) and the interest-bearing market (because all the instruments bear interest). The sharp reader will recognize the incongruence here: long-term NMD is also fixed-interest / interest-bearing, in other words, the terms apply to the STDM (= the money market) and the LTDM (the marketable part of which is the bond market).

 
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