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Getting a Handle on the Bond Market

Step 1: Is the Bond Market Different Than the Stock Market?

Getting A Handle On The Bond Market Splash image

While people speak of the bond market as if it were one market, in reality there is not one central place or exchange where bonds are bought and sold. Rather, the bond market is a gigantic over-the-counter market, consisting of networks of independent dealers, organized by type of security, with some overlaps. Whereas stocks sell ultimately in one of three independent exchanges, most bonds are sold dealer to dealer.

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This market is so vast that its size is difficult to imagine. Overwhelmingly, this is an institutional market. It raises debt capital for the largest issuers of debt, such as the U.S government, state and local governments, and the largest corporations. The buyers of that debt are primarily large institutional investors such as pension funds, insurance companies, banks, corporations, and, increasingly, mutual funds. These buyers and sellers routinely trade sums that appear almost unreal to a non-finance professional. U.S. government bonds trade in blocks of $1 million, and $100 million trades are routine. The smallest blocks are traded in the municipal (muni) market, where a round lot is $100,000. Another way of characterizing this market is to call it a wholesale market.

Enter the individual investor. In the bond markets, individual investors, even those with considerable wealth, are all little guys, who are trying to navigate a market dominated by far larger traders. Indeed, many of the new fixed-income securities created over the last 10 years were specifically tailored to the needs of pension funds or insurance companies and may not be appropriate for individual investors. In addition, many specific corporate and municipal bonds are illiquid, making pricing difficult.

The individual investor faces many disadvantages when compared to institutions. In order to protect your own interests, if you want to buy individual bonds, you need to become an informed investor, and you need to stick to bonds whose characteristics and risks you understand.

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