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Debt Capital Markets 101: How do the bond markets work?

So now you know a bit about what the debt capital markets are, let’s learn a bit about how they work in practice.

This post is the third in my series that introduces you to the world of debt capital markets.  If you haven’t read the previous posts, you can read them here.

In this post, I’ll be covering the following questions:

  • What are bonds?
  • Who issues them?
  • Who buys them?

So let’s start at the beginning and consider the first thing needed in order for a market to function: the product that is bought and sold, namely bonds.

What are bonds?

A bond is a legal agreement under which an issuer borrows from one or a number of investors for a given period of time. In return the issuer pays an agreed amount of interest. At the time of launch of the bond issue, all of the investors agree to the same set of terms (e.g. tenor, interest rate, currency, covenants). Thus, once issued, the bonds can be bought and sold interchangeably in the secondary markets.

Who issues bonds?

Bonds are generally issued by:

  • countries (known as ‘sovereigns’): e.g. the US, Germany, Japan, UK
  • supra-national organisations: e.g. the World Bank, European Investment Bank, Asian Development Bank
  • government-linked agencies: e.g. Federal National Mortgage Association (FNMA or ‘Fannie Mae’), Kreditanstalt für Wiederaufbau (KfW)
  • banks and other financial institutions: e.g. Citigroup, JP Morgan, Prudential
  • large corporations: e.g. GE, Coca-Cola

Who buys bonds?

Bonds are bought by a variety of different investor types:

  • investment managers – for the funds that they manage on behalf of individual investors or within investment funds
  • insurance companies – in order to invest the premiums paid by their own customers and to hedge against future insurance pay-outs
  • pension funds – to invest the funds raised from those of working age in order to pay out upon retirement
  • countries – to invest their foreign currency reserves e.g. China is a huge investor in US Treasuries)
  • hedge funds – to support whatever investment strategy they follow
  • banks – to invest their cash balances or in order to provide market-making services to their secondary market clients (many of whom they sell to in the primary market)

Wrap up

We’ll leave it there for now. In my next post, we’ll look at how debt capital markets departments are organised and then move into the specifics of the role of debt capital markets originator.

Cheers

Monty

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