Everyone knows that the stock market is big, but you know, the bond market is actually bigger. At the end of 2022, the U.S. bond market totaled $51.3 trillion, and the U.S. stock market totaled $40.5 trillion. Currently, there are 66,000 U.S. corporate bonds available for trading, and about 4,500 U.S.-listed stocks.

So, some investors may be wondering: Is such a big bond market the same as the rules of the game in the stock market?

Today's opportunity to explore the basic definition of bonds is to understand the relationship between the bond market and the stock market, and we'll mention some of the bond market's “playthroughs” below for your reference!

Direct Investment: Tier 1 and Tier II Markets for U.S. Treasury Bonds

Tier 1 market: The tier one market for government bonds refers to newly issued bonds. The U.S. Treasury sells tradable Treasury bonds to institutions and individual investors through a public auction, and the auction takes place on a fixed schedule. National debt supply is related to the interest rate on the fiscal expenditure element. When taxes on the main source of fiscal income are reduced, government fiscal revenue will depend more on the issuance of national debt; conversely, the increase in tax revenue will lead to a decline in the size of the national debt supply.

Tier II markets: Bonds can be traded on the Tier II market after issuance, but unlike the stock market, bonds are generally not traded on stock exchanges. Part of the reason is that bonds have a range of maturities, interest rates, and credit ratings that make the bond market more complex than the stock market, so bonds are often bought and sold at the counter through brokers or traders.

Basic characteristics of bonds

Face value: The face value or bill value is the amount that the bond issuer undertakes to repay the bondholder at maturity.

MATURITY DATE: THIS IS THE PAYMENT OF THE PRINCIPAL OR BILL AMOUNT TO THE INVESTOR AND THE DATE OF THE END OF THE BOND OBLIGATION, WHICH RANGES FROM 1 YEAR TO 30 YEARS.

Box Office Rate: Represents interest paid to bondholders, usually annually or semi-annually.

Issuer: The issuer of the bond is the entity that borrows the funds. It can be government, municipal or corporate.

After knowing the elements of bonds, the next key question is how are bond prices measured?

The price of bonds changes every day, and like any other publicly traded securities, the supply and demand relationship at any particular moment determines the observed price.

The price of a bond is the price that investors are willing to pay for an existing bond, usually offered as a percentage of the face value. For example: The bond has a face value of $20,000. Investors buy at a price of 90, which means they are willing to pay 90% of the face value, which is $18,000.

Here comes the key question, how do you make money investing in bonds?

1. Box Office Rate

Bonds give money at agreed interest rates and payment cycles, making it one of the main sources of income from investing in bond assets in banking products.

For example: a 5-year national bond issued by the country, denominated at $100, the box office rate is 3.5%, the interest income is paid annually. At this time, the income is $3.5/year.

2. Capital gains

Some investors may wonder: Since the interest rate on the bond is fixed, how will the yield of the corresponding financial products fluctuate?

This is because many bond investors do not have to wait until the bond matures, or can earn spreads by trading ahead of time.

The price investors are willing to pay for the bond may be affectedSignificant impact of current interest rates。 If the current interest rate is higher than the check rate on the already issued bond, the price of the bond that has already been issued will usually fall. This is because, as interest rates rise, new bonds may be issued at higher bill rates, which makes old bonds or outstanding bonds generally less attractive unless they can be purchased at a lower price.

Investors can keep this in mind:Higher interest rates mean a discount on the price of existing bonds.

For example, an investor buys a bond with a check rate of 3%, worth $1000, with an interest payment of once a year, with a maturity of 3 years. Assuming a current interest rate of 5%, the investor wants to sell the bond, how much is the buyer willing to pay?

First of all, we see that 5% > 3%, that is, the current interest rate is higher than the box rate. At this time, the bond is not attractive in a market environment with high interest rates, so investors are only willing to buy at a discount. Buyers may only be willing to buy with 94.6% of the face value, i.e. $945.5.

Conversely, if interest rates fall, the price of existing bonds often rises, which means that investors can sometimes sell bonds at a price higher than the purchase price. This is because, in an environment of low interest rates, other investors are willing to pay a premium for bonds with higher interest rates, so older bonds with high interest rates become more attractive.

Indirect investment: Get someone else to manage your investments

See here, are some investors feeling “a bit big”? There are so many elements of bonds that I don't understand! Hurry up. Next, we will introduce an indirect channel for investing in bonds — funds.

Currency Fund

First, let's introduce one of the most common methods in our daily lives, namely money funds. Currency funds are designed to provide investors with high liquidity and low risk, so investment benchmarks tend to be cash, cash-equivalent securities, and short-term high-credit rated debt securities, such as U.S. Treasuries.

Currency funds in the United States can generally be divided into three categories:

1. Government Monetary Market Fund:Invest primarily in government-issued short-term bonds and other similar highly credit-rated debt instruments to ensure the safety and liquidity of their portfolios. Such funds have relatively low returns, but the risks are also relatively small.

2. Quality Money Market Fund:Invest primarily in a variety of highly rated short-term corporate notes, bank debt securities, and corporate notes. These funds tend to offer higher rates of return, but bear correspondingly higher risks.

3. Municipal Monetary Market Fund:Invest primarily in debt issued by national and local governments, such as municipal bonds.

In addition, there is an index-based currency fund that tracks a specific index, so their portfolio includes the bonds or bills that that index represents. For example, Vanguard Treasury Currency Market Fund (VUSXX) tracks the performance of the Bloomberg Barclays U.S. Treasury Index.

Bond ETF

In addition to currency funds, investing in bond ETFs is also a good option.

Unlike regular bonds, ETFs are a collection of investments in a series of bonds, where investors can trade and trade ETFs just like stocks on an exchange. The structure of traditional bonds gives investors a high threshold for entry into bonds, while bond ETFs avoid this problem by trading on exchanges, while bond ETF providers also list basic metrics on the platform, such as maturity yield, credit quality, and longevity, simplifying the process for investors.

Compared to stock ETFs, bond ETFs also have a bond-specific advantage, where bond ETFs pay monthly dividends based on the interest income earned by bonds held in the fund's portfolio.

All in all, bond ETFs bring much-needed transparency, liquidity, and accessibility in the fixed-income field.

With so many advantages, let's talk about the risk points of bond ETFs below. Compared to the bond itself, there is a probability of loss in the bond ETF, which investors must pay attention to. For example, holding a 5-year Treasury bond, you can get the principal back as long as the holding matures, and the bill rate is fixed in advance, so the yield is certain; but the Treasury ETF has no maturity concept, so if things are bad, you may have a 5-year hold or a loss, and the final yield is uncertain. Just like the figure below, there is an upward and downward trend in ETFs.

Whether it's a mutual fund or an ETF, it's an indirect investment that belongs to bonds, and the benefits are obvious — allowing beginners to quickly invest in their favorite varieties. Not only is the minimum investment amount relatively low, and because funds generally hold more bonds, the diversification of investments increases, which can disperse relatively concentrated risks. But keep in mind that all investments are not entirely risk-free, even bonds are no exception.

What are the advantages and disadvantages of the investment bond market compared to the stock market?

pros

• Interest earned each period and principal received at maturity provide investors with a reliable source of income.

• A bond's credit rating allows investors to choose bonds that are best suited to their risk tolerance.

• It is possible to earn spreads on low-oversold markets in the second-tier market.

shortcomings

• Unlike stocks, upside potential is limited and returns may be lower.

• There may be problems with insufficient liquidity in the bond market. Some bonds are not so easy to sell.

• More complicated than stock trading, entering the major OTC markets requires finding a broker/trader to invest.