Bonds and Bond Derivatives, Second Edition

INTRODUCTION

This book focuses on bond markets and bond derivatives. The importance of these topics has grown considerably over the last 30 years because of increases in the levels of debt, considerable variability of interest rates, and development of many new varieties of debt instruments. Consequently, involvement of individuals and firms in the debt markets has expanded and the risks of incorrect decisions are large.

Growth of Debt

The debt obligations of households, businesses, and government are individually large and have been growing at rapid rates in recent years. Because of this increase in the size of the debt market, events in the debt market can have wide-ranging impacts upon the entire economic system.

To provide some indication of the size of the debt markets, Figure I.1 shows debt as a percentage of gross domestic product (GDP). The categories of debt are federal government debt, tax-exempt debt issued by state and local governments, corporate bonds, mortgage debt, and consumer credit.

Several important things are revealed by this figure. First, the absolute size of these debts is huge, especially US government debt and mortgage debt. Second, federal government debt was a very high percentage of GDP in 1945 following large borrowing during World War II. The federal government debt came down steadily into the late 1970s. Since 1980, federal government debt has been increasing as a percentage of GDP. Third, mortgage debt has been increasing steadily as a percentage ...