THE BOND MARKET

WHAT IS A BOND?

WHAT DOES A BOND MARKET DO?

• Channels funds from savers to borrowers
• Funds government debt
• Spreads risk
• Creates liquidity

THREE RISK TYPES OF BONDS

• Default risk
• Term risk
• Liquidity risk

DEFAULT RISK

• The risk that your loan won’t be repaid is called default risk
• Companies are giving credit ratings to help investors assess risk

INTEREST RATES RISE WITH DEFAULT RISK

TERM RISK

• The risk that arises from uncertainty about future interest rates is called term risk
• Tying up your money involves an opportunity cost
• This risk is connected to the length (or term) of the loan

LIQUIDITY RISK

• The risk that if you need to sell an asset quickly, you may not be able to get a good price for it is called liquidity risk

US GOVERNMENT BONDS ARE THE SAFEST INVESTMENT

• Bonds issued by the US government are called treasuries
• Around $500 billion in treasuries are traded every day

WHICH BOND PROBABLY PAYS A HIGHER INTEREST RATE?

• A 30 year bond
• A10 year bond

WHICH BOND PROBABLY PAYS A HIGHER INTEREST RATE?

• A bond issued by Nike
• A bond issued by the US government

REVIEW: THE BOND MARKET

• Both the bond market and banks channel funds from savers to borrowers and spread risk
• However, the bond market is different from banks in the size of loans made in the way that liquidity is created
• The bond market is also were government agencies borrow money
• Bonds are subject to default risk, term risk, and liquidity risk

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