The topic of the current paper is the US corporate bond market. It is highly important to study the role of bonds in the financial system of the United States as these days bonds are extremely popular in the country. It is associated with the fact that it is considered a reliable way to invest money. Thus, the purpose of the paper is to study such questions as methods of operation of the US corporate bond market and examine what electronic platforms are currently used. It should be noted that the US corporate bond market is regarded the best in the world. Therefore, a great number of authors have dedicated their works to the study of the specific principles of the bond market in the United States. In the paper, seven credible sources are used. With their help, it is possible to study all the necessary questions associated with the US corporate bond market.
These days, it is believed that investment in bonds is the most reliable one in the securities market. The corporate bond market is a market of bonds of companies and enterprises. According to profitability and terms of treatment, this market is more attractive to private investors. Corporate bonds represent a financial instrument, through which a private company may attract additional funds in its business activities. The issuer that issues the securities retains full control of the company, without restructuring the property. Corporate bonds allow entrepreneurs to make a profit due to lower interest rates than in banks. In such a way, this tool is recommended for people who are concerned with the full safety of capital having the income that is slightly higher than on bank deposits. Goals of short-term debts issuance are grounded on the attraction of money resources to increase the amount of circulating money.
The authors Stephen Valdez and Philip Molyneux (2015) affirm that “corporate bonds can, however, be quite long-dated” (p. 172). Significantly, long-term debts issuance is aimed at financing projects such as enhancement of the enterprise equipment. Every country has its corporate bond markets. In some countries, such markets are poorly developed, while in the others, corporate bond markets hold a significant position in the financial sphere. The US corporate bond market is considered one of the best in the world. Government bonds of the United States are regarded the most reliable investment instruments in the world. The purpose of the paper is to study peculiarities of the US corporate bond market and examine its main trading platforms.
Securities represent a necessary attribute of market economy. Their value lies in the rights that they give to the owner. A person exchanges goods or money for securities only if he/she is sure that they are not worse and even better than money or goods. Thus, securities are a form of existence of capital that is distinct from its commodity, productive, and monetary forms, which can be treated as a commodity on the market and generate income (Roggi & Altman, 2013). In the economic system of the state, the stock market performs important functions providing the accumulation of temporarily free funds for investment in promising sectors of the economy. Securities occupy an increasing share of working capital of enterprises. In fact, shares and bonds are considered the basic and most used corporate securities. In the book Corporate Bond Markets, it is noted that “a bond is a debt instrument usually paying a fixed rate of interest over a fixed period of time” (Choudhry, 2011, p. 3). Unlike shares, bonds of the companies do not give their holders the right to participate in the management of a joint stock company. Despite this fact, they are still an attractive means of investing temporarily free funds. It is explained by the fact that bonds generate guaranteed income. Moreover, they are easily converted into cash. Interest payments on the bonds of the company are conducted on a priority basis, namely to the accrual of dividends on shares. Furthermore, in the case of liquidation of the company, bondholders have a preferential right to shareholders (Choudhry, 2011). In the situation that has developed in the world today, it is more than ever important to use such financial instrument as a corporate bond.
The US stock market is one of the most developed markets in the world. During the post-war period, the United States constantly occupied the first place as the world’s largest stock market capitalization (Gitman, Joehnk, & Billingsley, 2013). Although the number of companies, the shares of which are traded on the stock exchange, has decreased, their number still exceeds the number of companies, whose shares are listed on stock exchanges in any other country in the world.
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According to the turnover of stock trading, the US stock exchanges also exceed other exchanges. Every year, American companies attract at the expense of open subscription for the shares from $150 to 200 billion of investments (Gitman et al., 2013). A spray, dispersed ownership structure and a high proportion of the instruments in the financial assets of the population are the causes of high capitalization and liquidity of the US stock market. In fact, approximately 91 million people in the United States have shares (Gitman et al., 2013). One-third of the share capital is directly in public ownership and half of it is in view of mutual funds (Gitman et al., 2013). The US companies are characterized by a very high free float. This fact makes the US market different from the market in Germany or Japan. Another reason for the attractiveness of US equities for investors is the high rate of dividend payments. In such a way, these facts show that the United States has a highly attractive stock market.
A great role in the US stock market is occupied by corporate bond market. Bonds of the United States are crucial for the world stock market (Arnold, 2015). The potential risks and possible yields are assessed on the basis of the situation relating to the US bonds. It is known that the lower is the risk of the instrument, the lower is the yield (Arnold, 2015). The United States of America has the highest credit rating in the world (Arnold, 2015). In this regard, the profit when talking about the United States corporate bonds is low and will satisfy not all private investors.
Bonds are a way to attract large amounts of long-term debt financing. It is logical that the issuers of corporate bonds are precisely those who are in need of funding, namely large enterprises that have stable business. Moreover, these are primarily large enterprises of mining and manufacturing industries and companies providing utility services, as well as financial institutions, particularly banks. Bonds are rarely used by enterprises from growing, high-tech industries. It is associated with the fact that these businesses do not typically have a high credit reputation and the probability of bankruptcy is higher (Gitman et al., 2013). Bonds never serve as a tool of small business financing. On the contrary, it is a financial tool for large and possibly medium-sized enterprises.
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In different markets, there are different reporting requirements and the size can be adjusted in various ways, for example, on the grounds of the volume of transactions in terms of money or their quantity. In each country, there is a certain minimum value, which makes the bond issue cost-effective. For the US market, this value is approximately $50 million (Gitman et al., 2013). In most other countries, the share of bonds issued by financial institutions in the total amount of private sector bonds is significantly higher (Gitman et al., 2013). Significantly, in such countries as Germany and Japan, the banks bonds account the vast majority of private sector bond issues. Therefore, every country has a different situation regarding the bond market.
Traditionally, the US bonds acted exclusively as a highly reliable financial instrument. Most bonds had a high rating. As a result of adverse changes, the bond rating could be reduced. However, the initial placement of unreliable bonds was not conducted. The situation changed dramatically in the 80s when the so-called junk bonds appeared (Gitman et al., 2013). Junk bonds became one of the main instruments tor finance rapidly growing companies. This type of bond was often issued to implement the acquisition of other companies or repurchase by the company of its shares with the purpose of redistributing the stock ownership structure. In any case, through the issuance of such bonds, the debt ratio increased sharply (Gitman et al., 2013). Accordingly, the reliability of the company’s bonds reduced. Due to the issuance of junk bonds, most of the largest acquisitions in the 80s were conducted in the United States (Gitman et al., 2013). Later, the situation changed and junk bonds stopped issuing.
Bonds should be in demand; in such a way, they can be used as a financial instrument. Investors show demand for the bonds. These are economic entities that have temporarily free funds. In most cases, investors have a fairly wide range of alternatives to investments of the funds such as bank deposits, purchase of shares, the purchase of foreign currency and gold, real estate, and other variants. There are the main groups of investors who buy corporate bonds. They include banks, non-banking financial institutions such as insurance companies, pension funds, or mutual funds, private investors, and corporate investors (Gitman et al., 2013). In comparison with investment in shares, bond investments are focused on more conservative terms. Accordingly, the structure of the bondholders is somewhat different than. Bonds in the long period of time are not the most profitable tool.
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Despite this, there are still certain important advantages of corporate bonds. First of all, it is a low risk. Holders of bonds may be confident in receiving certain amounts in the future. Nevertheless, it cannot be said about the owners of shares. The second benefit lies in convenience of investments. In fact, gold and antiques are also considered low-risk forms of investment. Nonetheless, work with them is associated with greater problems since these items must be stored and protected from theft. In addition, sale of gold and antiques may require a long period of time and high cost. Since bonds are less risky, they are actively acquired by those who have a high level of risk on the liabilities, insurance companies, pension funds, or banks (Gitman et al., 2013). However, individuals often want to accept a higher level of risk to get more income. Therefore, the share of private investors among holders of the bonds is less than among the holders of higher-yielding instruments.
The so-called investment funds acquire great popularity in the United States. The idea of the investment activity of the fund is that the fund accumulates savings through the issuance of its securities and invests them into securities that exist in the stock market. In this case, the investor investing in a fund owns part of the fund’s portfolio. Investment funds may invest to specific types of securities, for example, only the shares or bonds or in different types of securities (Gitman et al., 2013). It is worth noting that specialized funds of bonds or balanced funds are the most active in the bond market. Balanced funds invest part of the assets in shares, while some invest in bonds.
The US bonds have several peculiar parameters. First of all, it is the nominal value. It is the amount that the trader gives in debt to the United States and that will be refunded at the time of retirement of bonds (Gitman et al., 2013). Another aspect is the circulation term (Gitman et al., 2013). It is a period within which the trader receives the income and has the right to sell the paper in the secondary market. Before the termination of handling, the investor cannot go to the issuer for a refund of the deposited amount. However, in the case when it comes to long-term instruments, the period until the expiration of the treatment of the paper is provided, when investors can return their money. The next aspect is the market value. It is the amount a trader pays for a bond. It is formed on the basis of the yield of the US Treasury bonds, proximity of the repayment period, a type of bonds, and other factors (Gitman et al., 2013).
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As a general rule, the closer is the repayment period, the closer is the market price to nominal. There is an additional tendency. The higher is the value of the shares and stock indices, the lower is profitability and the market price of the bonds. The cost of the US bonds is expressed in 32 fractions of points, which is 1% of the nominal value (Gitman et al., 2013). Prices are usually written with a hyphen, for example, 99-16, which totals 99.5% of the nominal value (Gitman et al., 2013). There is also such notion as the rate of interest. In the case of bonds with a maturity of one year, the percentage of income is set that investors get quarterly or annually. This indicator forms the yields of the US bonds. In such a way, the US bond market has many characteristics, which make it different from bond markets of other countries.
In the US bond market, there exist some types of securities. Among them, the most popular are treasury bills, treasury notes, and the US treasury bonds. Treasury bills are issued for a period of 3, 6, and 12 months (Gitman et al., 2013). The yield on these instruments is generated through the sale of shares at a discount in relation to the nominal price. The discount rate is a price discount per 360 days. For example, the bill of the nominal value for $10,000, the maturity of which ends after 360 days with a discount of 0.46, will be priced at $9954 (Gitman et al., 2013). Treasury notes are medium-term government debt instruments (2-10 years), in which investors are paid a fixed percentage (Gitman et al., 2013). The US treasury bonds are issued for a period of 10 years (Gitman et al., 2013). They suggest coupon payments. In the long-term coupon bonds, the investor is paid the aggregate percentage equal to the coupon rate, while the US Treasury pays half of the coupon rates every 6 months (Gitman et al., 2013). Therefore, all these types of bonds are highly popular in the United States.
A special kind of the US debt bonds are TIPS. In the book Bond Investing for Dummies, it is written that “TIPS offer only very modest interest rates but the principal is readjusted twice annually to keep up with inflation” (Wild, 2012, p. 46). In such a way, these are bonds that are protected against inflation. In addition to them, there are non-standard issues of securities, including Cash Management Bills that short-term promissory notes used by the leadership of the country in case of emergency and characterized by higher coupon payments and 20-year bonds. As a rule, the sales volumes of non-traditional securities are significantly lower monthly tranches of 3-year and 10-year old bonds (Wild, 2012). The US mortgage bonds are papers supplied by the property, which makes them even more attractive in terms of reliability.
Corporate bonds include a wide variety of instruments such as traditional unsecured corporate bonds called debentures and multiple papers that have appeared in the securitization procedure, namely ABS, CMO, and MBS (Wild, 2012). In the US market, there are annually from $2.5 trillion up to 3 trillion bonds (Wild, 2012). One of the distinctive features of the American market of corporate bonds is the amount of short-term commercial papers. One of the main reasons for their popularity is that this type of corporate bonds does not require registration in the US Securities and Exchange Commission (Wild, 2012). At the moment, the interest in corporate securities rouses investors’ concerns about the future of the US economy as well as more serious problems in the euro zone. Over the US and many other countries, there is a threat of the credit rating downgrade. It may have a significant effect on the value of government securities. At the same time, corporations have accumulated a record cash reserve and have modest short-term debts. Profits of most American corporations are stronger than European ones (Wild, 2012). In addition, in the United States, there is a greater number of companies that improve their credit rating, as opposed to those who reduce it. It attracts investors in the US corporate bonds.
There is a mechanism of realization of the US corporate bonds. In the book Fundamentals of Corporate Finance, it is stated that “bonds can be issued publicly or placed privately” (Berk et al., 2013, p. 452). However, in general, the procedure of realization of the US corporate bonds is rather complicated. It is connected with the fact that a private investor cannot participate in the initial public offering. Professional customers can purchase treasury notes and bonds directly from the US Treasury or in brokers and banks. There is an institute of primary dealers. These are companies appointed by the US Federal Reserve that are engaged in the primary distribution of new securities (Berk et al., 2013). Evidently, their task is to support liquidity in the bond market. Each dealer is responsible for a specific market. For example, Deutsche Bank Securities Inc., BNP Paribas Securities Corp., and Barclays Capital Inc. are focused on the European market, while Mizuho Securities USA Inc. and Daiwa Capital Markets America Inc. perform the sale of bills, notes, and bonds among investors in Japan (Berk et al., 2013). The main participants in the US bond market are Federal Reserve, Treasury, Wall Street participants, and central banks around the world. All operations are performed only by means of transfer.
There is a specific procedure for issuance of treasury bonds. Thereafter, seven days before the auction, there is the announcement of its conduct with indication of the maturity date of the paper, the settlement day, and the volume of sales. Some types of securities can be sold in a single auction. Representatives of Wall Street after the publication of the announcement are eligible for trade with the announced release to the moment when the purchase of this issue is calculated. Before the appearance of the report on the auction, traders do not know a coupon rate of the income, which is determined on the basis of the average yield of the auction. Calculations are made on the day of the transaction or the next day via the Federal Reserve Bank (Berk et al., 2013).
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The transfer of ownership occurs through a system of accounting entries. For investors who are planning to work with the US government bonds, it is necessary to determine for how long they want to invest and what rate of return they expect. Traditionally, the percentage of the income on treasury debt securities is low. Therefore, the main purpose of investment is primarily the preservation of existing resources. From this standpoint, it is important to evaluate the stability of the US economy.
It is important to note that in the US corporate bond market, there are several electronic trading platforms. In general, there are nineteen bond platforms in the United States (Arnold, 2015). The author Glen Arnold (2015) states that “many such platforms are operating but they still account for only 1% of trades” (58). In the article Electronic Trading in Fixed Income Markets, it is noted that “A large variety of new trading platforms have emerged that facilitate corporate bond intermediation” (Markets Committee, 2016, p. 12). eSpeed occupies a leading position among other electronic platforms (Arnold, 2015). It is an electronic trading platform that allows users to perform transactions with different kinds of securities, including the US Treasury bills, eurobonds, securities of the US federal agencies, non-US government bonds, municipal bonds, corporate bonds, and bonds of new market countries (Arnold, 2015). BrokerTec Global is considered number two. This electronic inter-dealer trading system was established by 12 major European and US investment banks (Arnold, 2015). The company is based in the US state of New Jersey. BrokerTec Global conducts the transaction both in the American and European markets (Arnold, 2015). TheMuniCenter is an anonymous electronic system for securities trading with a fixed interest rate. Garban Intercapital has long been considered the leading voice broker for bond trading, derivatives, and currencies. Based in New York, the company Instinet Fixed Income Markets owned by Reuters Group offers services for online trading by the US and European debt securities, which became part of the company’s extended services that also includes e-commerce stocks. Securities transactions are conducted always anonymously and in all transactions, Instinet acts as a trading partner (Arnold, 2015). The company’s management affirms that Instinet Fixed Income Markets became a pioneer of electronic trading stocks for more than 30 years ago. TradeWeb is an electronic trading system that was created in 1998 (Arnold, 2015). It allows investors to buy and sell treasury bills and the US securities of the US federal agencies online directly through multiple dealerships. Many experts consider this platform as an undisputed leader in the modern electronic securities market (Arnold, 2015). Most respondents-investors have confirmed the use of this platform (Arnold, 2015). Although some traders claim that “dealer-to client” systems have less impact on the functioning of the market, they recognize the major role played by TradeWeb in the expansion of direct access of investors to the bond market. It should be noted that in general, most of the platforms are oriented to dealer-to-dealer markets (Markets Committee, 2016). Market Axess is another famous trading platform. However, some traders are suspicious of Market Axess and find it too difficult to use; nevertheless, this system was funded by several major investment banks. For example, representatives of the trade department of a reputable US bank that invested in the creation of Market Axess note that the system is highly cumbersome and slows the trading operations (Arnold, 2015). When dealers are really busy, the use of Market Axess sometimes causes severe irritation. Despite this fact, TradeWeb, Market Axess, and a number of other systems that have achieved tangible indicators in the US financial market have expanded their operations to European countries. Special attention should be paid to TRACE. It was introduced at the beginning of the XXI century. In the book Managing and Measuring Risk, it is written that “this database aggregates virtually all transactions in the US corporate market” (Roggi & Altman, 2013, p. 161). The aim of TRACE is to increase transparency of prices in the corporate debt market of the United States. It is seen that there is a great number of different trading platforms in the US bond market.
The modern financial system of the state cannot be imagined without a developed securities market and, in particular, without the corporate bond market. Securities are essential instruments of a market economy. The main corporate securities are divided into shares and bonds. The corporate bond market is one of the youngest and fastest growing elements in the structure of the securities market. The corporate securities market, as one of the segments of the financial system, is an essential element of a viable market economy. Bonds are generally considered a safer investment tool than shares because their owners have a priority in the demand for the proportion of the company’s assets in the event of liquidation or restructuring. For issuers, bonds are a safe alternative to banks and other lenders that may offer less attractive financial terms than capital markets. It should be noted that bonds are more frequently used by big businesses.