7.2 Fixed-Income Markets: Issuance, Trading, and Funding - 7.2 Fixed-Income Markets: Issuance, Trading, and Funding Explained
Key Concepts
- Issuance of Fixed-Income Securities
- Trading of Fixed-Income Securities
- Funding in Fixed-Income Markets
- Primary Market vs. Secondary Market
- Market Participants
Issuance of Fixed-Income Securities
Issuance refers to the process by which fixed-income securities, such as bonds, are initially sold to investors. This process involves the issuer (typically a government or corporation) raising capital by offering debt instruments to the public. The issuance can be done through public offerings or private placements.
Example: A corporation decides to issue $100 million worth of bonds to fund a new project. The bonds have a face value of $1,000 each and a coupon rate of 5%. Investors can purchase these bonds directly from the issuer during the initial offering period.
Trading of Fixed-Income Securities
Trading involves the buying and selling of fixed-income securities after their initial issuance. These transactions occur in both the primary and secondary markets. In the secondary market, investors trade existing bonds among themselves, providing liquidity and price discovery.
Example: After the initial issuance, an investor who owns one of the corporation's bonds decides to sell it. The bond is listed on a trading platform, and another investor purchases it at the current market price, which may be higher or lower than the face value depending on market conditions.
Funding in Fixed-Income Markets
Funding refers to the use of fixed-income securities as a means of raising capital. Issuers use the proceeds from bond sales to finance various activities, such as infrastructure projects, corporate expansions, or budget deficits. Investors provide funding in exchange for the promise of regular interest payments and the return of principal at maturity.
Example: A municipality issues municipal bonds to fund the construction of a new public library. The proceeds from the bond sale are used to finance the project, and the municipality repays the investors through regular interest payments and the return of principal when the bonds mature.
Primary Market vs. Secondary Market
The primary market is where new securities are issued and sold to investors for the first time. The secondary market is where existing securities are traded among investors. The primary market provides capital to issuers, while the secondary market provides liquidity to investors.
Example: In the primary market, a government issues new treasury bonds to raise funds for public spending. In the secondary market, investors trade these treasury bonds among themselves on stock exchanges or over-the-counter (OTC) markets.
Market Participants
Market participants in fixed-income markets include issuers (governments, corporations), investors (individuals, institutions), brokers, dealers, and market makers. Each participant plays a role in the issuance, trading, and funding processes, ensuring the smooth functioning of the market.
Example: A pension fund is an institutional investor that purchases corporate bonds to generate income for its beneficiaries. A broker facilitates the transaction between the pension fund and the bond issuer, while a market maker provides liquidity by standing ready to buy or sell bonds at quoted prices.