Introduction to Fixed-Income Markets
Fixed-income markets are where debt securities are created and traded. Unlike equity markets, the fixed-income universe is incredibly diverse, with securities defined by their issuer, credit quality, maturity, and currency. The market is broadly split into two main parts:
- Primary Markets: Where new bonds are issued for the first time to raise capital.
- Secondary Markets: Where existing bonds are traded among investors.
Fixed-Income Segments, Issuers, and Investors
Categorizing the Fixed-Income Market
The vast fixed-income market is categorized along several key dimensions:
| Category |
Description |
| Issuer Type |
Governments (sovereign, local), Corporations, and Securitized (e.g., Mortgage-Backed Securities). |
| Credit Quality |
The likelihood of the issuer defaulting on its payments, assessed by credit rating agencies. |
| Time to Maturity |
Short-term (less than 1 year), intermediate-term (1–10 years), and long-term (more than 10 years). |
| Other Factors |
Geography, currency of denomination, and ESG (Environmental, Social, and Governance) characteristics. |
Fixed-Income vs. Equities: A key difference is diversity. A single company typically issues only one or two classes of common stock. However, the same company can issue dozens of different bonds with varying maturities, currencies, and seniority, creating a much larger and more complex universe of securities.
Credit Rating Insights
Credit rating agencies like S&P and Moody's play a crucial role by assessing an issuer's default risk. These ratings directly impact a bond's yield and price.
| Rating Category |
S&P Ratings |
Description |
| Investment Grade |
AAA down to BBB– |
Issuers with a high capacity to meet their financial commitments. Considered lower risk. |
| High Yield (Junk) |
BB+ down to C |
Speculative-grade issuers with a higher risk of default. |
| Default |
D |
The issuer has defaulted or is expected to default with little chance of recovery for investors. |
Fallen Angels: These are issuers that were once rated investment grade but have been downgraded to high yield.
Investors in Fixed-Income Markets
Different types of investors participate in different segments of the market based on their risk tolerance, liability-matching needs, and investment horizon.
- Default Risk-Free (e.g., U.S. Treasuries):
- Short-Term: Money Market Funds
- Intermediate-Term: Central Banks, Financial Intermediaries
- Long-Term: Pension Funds
- Investment Grade:
- Short-Term: Corporate Treasurers
- Intermediate-Term: Bond Funds, ETFs
- Long-Term: Insurance Companies
- High Yield:
- Short-Term: Asset Managers
- Intermediate-Term: Hedge Funds, Distressed Debt Funds
Fixed-Income Indexes
Fixed-income indexes (or bond indexes) serve as benchmarks to measure the performance of the market and of investment managers. They differ from equity indexes in several important ways:
- Number of Constituents: Bond indexes contain far more securities than equity indexes.
- Frequent Changes: The constituents of a bond index change constantly as old bonds mature and new bonds are issued.
- Weighting: They are usually weighted by the market value of the issuer's outstanding debt.
Investors must choose an index that aligns with their investment strategy. Increasingly, ESG factors are used to screen and exclude certain issuers from indexes.
Primary and Secondary Fixed-Income Markets
The Primary Market: New Issuance
The primary market is where issuers sell new bonds to investors to raise capital.
- Process: The process can be a public offering or a private placement. Debut issuers go through a detailed process, while frequent issuers often use a streamlined approach like a shelf registration.
- Underwriting: Investment banks act as underwriters, managing the sale process. For high-quality bonds, they often buy the entire issue and resell it (firm commitment). For lower-quality bonds, they may agree to sell the bonds on a best-efforts basis.
- Issuance Methods:
- Corporate Bonds: Typically issued via underwriters.
- Sovereign Bonds: Typically issued through public auctions.
- Private Placements: Bonds sold directly to a small group of specialized institutional investors.
The Secondary Market: Trading of Existing Bonds
The secondary market facilitates the trading of existing bonds, providing liquidity and price discovery.
- Structure: The fixed-income secondary market is predominantly an over-the-counter (OTC) or quote-driven market, where dealers post bid (buy) and ask (sell) prices.
- Participants: The main players are institutional investors, financial intermediaries, and central banks.
- Liquidity: Liquidity can vary dramatically.
- Newer ("on-the-run") and higher-credit-quality bonds are generally more liquid.
- The bid-offer spread (the difference between the bid and ask price) is a key measure of liquidity; a narrower spread means higher liquidity.
- Pricing for illiquid bonds is often estimated based on the prices of more liquid bonds with similar characteristics.