An overview of fixed income securities and markets

Abstract

Capital markets comprise equity markets and debt markets. Debt markets are for issuance and trading of fixed income securities. Fixed income securities can be issued by central and state governments, companies, and financial institutions.Worldwide, the debt market is several times bigger than its equity counterpart. In the United States, for example, the size of the debt market is valued at more than $ 45 trillion, which, when compared to the size of the equity market, can be deemed to be an extremely huge source of capital. This chapter has the following objectives: • Introduce bond valuation • Discuss measures of bond price volatility • Introduce fixed income innovations • Highlight the role played by credit rating agencies • Discuss how credit risk premium can be estimated using option pricing theory 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. As of 2006, the size of the international bond market is an estimated $ 45 trillion, of which the size of the outstanding US bond market debt was $ 25.2 trillion. Nearly all of the $ 923 billion average daily trading volume (as of early 2007) in the US bond market takes place between broker dealers and large institutions in a decentralized, over the counter (OTC) market. However, a small number of bonds, primarily 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.1 Like stocks, bonds are also traded on exchanges (e.g., New York Stock Exchange). The 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 1,000 to 6,000. The NYSE Bonds trading platform provides a more efficient and transparent way to trade bonds. The platform incorporates the design of the current NYSE Arca all-electronic trading system. This system provides investors with the ability to readily obtain transparent pricing and trading information, enabling them to make better investment decisions. The system has also been expanded to include the bonds of all NYSE-listed companies and their subsidiaries without the companies having to list each bond issued. NYSE Bonds operates the largest centralized bond market of any US exchange or other self-regulatory organization. It offers investors a broad selection of bonds: corporate (including convertibles), agency, and government bonds. The majority of NYSE bond volume is in corporate debt, with some 94% in straight, or nonconvertible bonds, and 6% in convertible debt issues. The securities industry and Financial Markets Association classifies the broader bond market into specific categories like Corporate, Government and Agency, Municipal, and Mortgage-Backed, Asset-Backed and Collateralized debt obligation. Bond market participants include institutional investors, governments, traders, and individuals. © 2009 Springer-Verlag Berlin Heidelberg.