An Introduction to the Bond Markets

1

What Is a Bond And Who Issues Them?

Over many years whenever I mentioned the bond market socially, people would often enquire ‘What is a bond?’, as if bonds were something from outer space. This would never happen if one were to mention the equity or share markets. On explaining that if bank loans or mortgages were tradeable they could be regarded as types of bonds and that many governments raise money by issuing bonds, many people immediately lost interest. This need not be the case; bonds can be sexy! However, unlike equities, except in the case of a few structured deals, the possibility, however remote, of a nearly infinite return is impossible.

In general terms, a bond is a loan by one party (the investor or holder) to another party (the issuer). The issuer gives the investor a guarantee that he or she will pay interest on the loan at regular intervals and repay the loan at a specified time in the future. In addition, the issuer may retain or grant embedded options that he or she or the investor can exercise in the future.

The terms ‘bonds’¹ and ‘loans’ have been used almost interchangeably throughout the book. The description ‘note’ is also used extensively, but it frequently refers to a bond that was originally issued for a period of not more than five years or to a floating-rate note. In addition, bonds have sometimes been referred to as ‘stocks’, which is a term that has been used by the Bank of England over many years to refer to UK Government gilt-edged issues. Its ...