Question

please explain what is the process by which bonds are traded? How does it compare the to the process for stocks?

Answer 1

Solution:-

The Bond Market

The bond market is where investors go to trade (buy and sell) debt securities, prominently bonds, which may be issued by corporations or governments. It is also known as the debt or the credit market. Securities sold on the bond market are all various forms of debt. By buying a bond, credit, or debt security, you are lending money for a set period and charging interest—the same way a bank does to its debtors.

The bond market provides investors with a steady, albeit nominal, source of regular income. In some cases, such as Treasury bonds issued by the federal government, investors receive bi-annual interest payments. Many investors choose to hold bonds in their portfolios as a way to save for retirement, for their children's education, or other long-term needs.

Investors have a wide range of research and analysis tools to get more information on bonds. Investopedia is one source, breaking down the basics of the market and the different types of securities available. Other resources include Yahoo! Finance's Bond Center and Morningstar. They provide up-to-date data, news, analysis, and research. Investors can also get more specific details about bond offerings through their brokerage accounts.

Where Bonds are Traded

The bond market does not have a centralized location to trade, meaning bonds mainly sell over the counter (OTC). As such, individual investors do not typically participate in the bond market. Those who do, include large institutional investors like pension funds foundations, and endowments, as well as investment banks, hedge funds, and asset management firms. Individual investors who wish to invest in bonds do so through a bond fund managed by an asset manager.

New securities are put up for sale on the primary market, and any subsequent trading takes place on the secondary market, where investors buy and sell securities they already own. These fixed-income securities range from bonds to bills to notes. By providing these securities on the bond market, issuers can get the funding they need for projects or other expenses needed.

Who Takes Part in the Bond Market?

The three main groups involved in the bond market include:

• Issuers: These are the entities that develop, register, and sell instruments on the bond market, whether they're corporations or different levels of government. For example, the U.S. Treasury issues Treasury bonds, which are long-term securities that provide bi-annual interest payments for investors and mature after 10 years. Investing in certain sectors of the bond market, such as U.S. Treasury securities, is said to be less risky than investing in stock markets, which are prone to greater volatility.
• Underwriters: Underwriters usually evaluate risks in the financial world. In the bond market, an underwriter buys securities from the issuers and resells them for a profit.
• Participants: These entities buy and sell bonds and other related securities. By buying bonds, the participant issues a loan for the length of the security and receives interest in return. Once it matures, the face value of the bond is paid back to the participant.

Bond Ratings

Bonds are normally given an investment grade by a bond rating agency like Standard & Poor's and Moody's. This rating—expressed through a letter grade—tells investors how much risk a bond has of defaulting. A bond with a "AAA" or "A" rating is high-quality, while an "A"- or "BBB"-rated bond is medium risk. Bonds with a BB rating or lower are considered to be high-risk.

Compare the to the process for stocks:-

One major difference between the bond and stock markets is that the stock market has central places or exchanges where stocks are bought and sold.

The other key difference between the stock and bond market is the risk involved in investing in each. When it comes to stocks, investors may be exposed to risks such as country or geopolitical risk (based on where a company does business or is based), currency risk, liquidity risk, or even interest rate risks, which can affect a company's debt, the cash it has on hand, and its bottom line.

Bonds, on the other hand, are more susceptible to risks such as inflation and interest rates. When interest rates rise, bond prices tend to fall. If interest rates are high and you need to sell your bond before it matures, you may end up getting less than the purchase price. If you buy a bond from a company that isn't financially sound, you're opening yourself up to credit risk. In a case like this, the bond issuer isn't able to make the interest payments, leaving itself open to default.

Stock market performance can broadly be gauged using indexes such as the S&P 500 or Dow Jones Industrial Average. Similarly, bond indices like the Barclays Capital Aggregate Bond Index can help investors track the performance of bond portfolios.