Beginner’s Guide to the Bond Market

What is a bond? Depending on who you ask, the word bond can either refer to a specific type of financial instrument, or when capitalized, your favorite British Secret Service agent. For this guide, we’ll be talking about the lowercase version, which represents one of the largest financial markets in existence. While fixed income, debt, or credit don’t have the same ring to them, they all refer to the same thing – money borrowed by some entity for a definite period of time and owed to another party. These parties are known as the debtor and creditor, respectively.

Bond Market vs. Stock Market

The bond market operates differently from the stock market. The stock market involves the exchange of shares of a company, representing ownership in that company. The bond market, however, involves lending money to the issuer for a certain period, up until the maturity date. Along the way the issuer pays out interest, the bond’s “coupon.” Almost all coupons payout every six months for the life of the bond. Most bonds also are quoted in $100s or $1000s, a term called “par value.” In contrast, the major stock exchanges today allow investors to buy a small fraction of a share.

Generally, most consider bonds less risky than the stock market. This is because bondholders have a higher claim on company assets than shareholders if the company goes bankrupt. Furthermore, most bonds offer fixed interest payments, providing a steady income stream. On the other hand, while many stocks offer dividends, these can fluctuate based on the company’s performance. Typically bonds that have longer maturities offer higher payments over time, to compensate holders for locking up their money for longer.

Bond Chart

Source: Vanguard

The reason many understand the stock market better than the bond market is due to the streamlined way in which individual investors, like you or me, can transact in them. In the U.S., there are about 6,000 international and domestic stocks listed on the New York Stock Exchange (NYSE) and NASDAQ, the two main exchanges in the United States. There are also over 10,000 stocks that trade “over the counter,” or off of a major exchange.

Stocks represent fractional ownership in a company at a certain price. The only thing that can really vary with common stock is its dividend yield and your voting rights on company issues as a shareholder. Bonds on the other hand come in all different kinds of flavors.