Training Document On The Us Bond Market

Training Document on the US Bond Market

Introduction

The US bond market is fairly easy to understand. Bonds are like loans that the government or corporations issue at a known interest rate for a certain amount of time. This interest rate is for the life of the bond and is paid out semi-annually to the bond holder. They are usually held for long periods of time, such as five years or more. The face value of the bond, which is the amount paid for the bond, is repaid to the bondholder according to the maturity date of the bond (the maturity date being the life of the bond or the set amount of time that the bond is set up for). People like to invest in bonds because they are generally low risk and interest rates are fairly easy to predict.

But what important information do we need to know about bonds? There are a lot of main questions to answer about the basics of bonds. We will discuss these questions in the following training document to better understand the US Bond Market. What types of markets are there for bonds? Who are the key players in the bond market? What types of bond investments are available to the individual and to institutional investors? What are the different ways that bonds bought and sold? How are stocks and bonds related or different from one another? Once we have answered all of these questions, you should have a better grip on the basics of bonds.

Bond Markets

There are two main markets for bonds. The first is called the primary market "in which new issues of securities are sold to the public" (Gitman & Joehnk, 2005, p. 36). This means that when the government or a corporation issues new bonds to sell to the public, they reap the profits from the sales of the bonds to fund government programs or corporate expansions or any other reason for which they might need the money.

The other is the secondary market, which is where the bonds can be re-issued by the corporation or the first issued bonds can be sold by current bondholders to other people at their designated price. The profit from the sale in this case does not go to anyone but the original bondholder.

Key Players in the Market

There are several key players in the bond market which include issuers, underwriters, and purchasers. Issuers are those who "sell bonds or other debt instruments in the bond market to fund the operations of their organizations" (Investopedia.com, 2007). Those who are considered issuers are the government, corporations, and banks. The government is the biggest issuer because they use the money from the bonds to fund most of their state wide social programs and other necessary funding.

The underwriters are the companies that help the issuers sell the bonds. It is usually done by financial institutions or banks. They make sure that all the necessary legal paperwork is taken care of since so much money is being transacted at one time for the large amount of bonds that will be sold. This paperwork includes the prospectus, which is the proposed offer to the company for the sale of the bonds. "The prospectus includes company facts that are vitally important to potential investors" (Investopedia.com, 2007).

And last, but certainly not least, are those who are the purchasers of the bonds on the market. This includes anyone and everyone that wants to invest in the issued bonds. They play a big role because they are actually the ones investing in the bonds and loaning their money to the government and corporations.

Types of Investments

Government Bonds

There are several types of bonds that individuals and institutional investors can invest. "Bonds range from U.S. Treasury (or Euro) bonds, bills or notes (the terms refer to different maturities - the number of years before the principal is repaid), considered among the lowest risk, down to corporate junk bonds or worse" (7search.com, 2007). Us treasury bonds are offered for more than ten years, bills are offered for less than one year, and notes are offered from one to ten years. They are also very low risk, and have reliable returns. So, you can help make your decision based on the maturity date of the bond you want. Other types of investments include corporate bonds, municipal bonds, and junk bonds.

Corporate Bonds

Corporate bonds are issued by corporations usually to raise funds for things like expansion, paying off debts, or other reasons. They are usually pretty reliable but some companies default when repayment time comes around. "Fortunately, Moody's and Standard & Poor's (as well as other firms) rate credit risk on bonds according to often highly reliable scales ranging from AAA (very low risk, but usually low yield) to D (don't even think about it), with BB considered junk range (risky, but high yield)" (7search.com).

Municipal Bonds

"Municipal bonds are issued by states, cities, and counties, or their agencies (the municipal issuer) to raise funds" (Wikipedia.com, 2006). They are fairly low risk and have pretty reliable repayment. The best way to determine the risk is to check the credit risk rating. The good thing about these bonds is that they are usually tax free however they may have a higher tax after the yield is paid.

Junk Bonds

Junk bonds are risky high yield bonds. This means that you could make a quick profit, but beware that you could lose everything you put in, too. This type of bond requires a lot of research and great guessing on the buyer's part.

Transactions of Bonds

Bonds can be bought and sold in a couple of different ways. First we will discuss how to buy a bond with cash. We need to research the kind of bond we want to purchase at the interest rate in which we will be satisfied because once that interest rate is locked in we cannot change it for the life of the bond. Once we have