Bond industry - Business in United States of America
Definition: Enterprises—including government entities—that issue and trade in interest-bearing promissory notes, initially issues to raise money for a particular entity or project
Significance: The bond industry enables governments to fund major infrastructure improvements and corporations to finance various stages of development.
Bonds are financial instruments by which buyers lend money to sellers under the terms outlined for each particular bond. They are thus debt instruments and are issued for a certain value (par value), for a set period of time (ending at their maturity date), at a given interest rate, and generally with some other provisions, such as whether the bonds can be “called early” (paid off prior to their maturity date). The interest paid on bonds represents their cost to the borrower/seller. This cost is affected by the bond purchaser’s confidence that the interest payments and principal can be covered by the issuer. The less confidence the market has in a particular issuer, the more interest the issuer will need to offer to convince investors to bear the risk of purchasing its bonds.
Since 1909, rating systems have been used to indicate the general perception regarding an issuer’s ability to make payments on its bonds. The less certainty there is that the issuing entity can make the needed bond payments, the lower the rating (AAA is the highest) will be—and the higher the interest demanded by those seeking to purchase its bonds. Once a bond has been issued, generally the purchaser of that bond can sell it to others before its maturity date. However, the value of the bond might not be the par value if interest rates have changed since the bond was issued or if the creditworthiness of the issuer has changed.
Bonds issued by state or local governments are generally issued for a specific purpose, such as building a school or constructing a bridge. The U.S. federal government uses bonds to cover budgetary deficits. Traditionally the maximum length of time for a bond to reach maturity is thirty years. U.S. government bonds are usually understood to be the safest in the world. Corporate bonds are issued by corporations for almost any imaginable purpose. Because the default risk is greater for corporations than for governmental entities, the interest rate on their bonds is generally higher than on government bonds.
Although there are substantial government regulations on the bond market, in the United States, most of the sales are done in private trades. This is because most bonds are not interchangeable, as are shares of stock. Although bonds such as those from the U.S. Treasury can be seen as comparable and are issued in large quantities, a bond for county bridge construction is not interchangeable with a bond for a private corporation to expand a manufacturing plant. Internationally, there are large markets that account for about one-third of the world’s debt trades. The Bond Market Association is an organization that represents these centers for debt securities trading.
Goodman, Jordan E. Everyone’s Money Book on Stocks, Bonds, and Mutual Funds. New York: Dearborn Trade, 2002.
Mishkin, Fredric S., and Stanley G. Eakins. Financial Markets and Institutions. 6th ed. Boston: Pearson Prentice Hall, 2009.
Wild, Russell. Bond Investing for Dummies. Indianapolis: Wiley, 2007.
See also: commodity markets; government spending; Junk bonds; Mutual fund industry; Pension and retirement plans; stock markets.