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The bond market, what is it and how does it work?

The bond market is an important component of financial markets, where investors purchase debt securities issued by governments, companies, or other institutions. Bonds represent a loan made by the investor to the issuer, who commits to repay the money with initially established interest. These investments are generally considered low risk, as the issuer pledges to repay the money at maturity and pay the initially agreed-upon interest.

The price of bonds depends on the current interest rate and the issuer’s risk assessment. If the interest rate increases, bond prices decrease, while if the interest rate decreases, bond prices increase. Price and yield are inversely proportional in the bond market.

Yield is the effective interest rate that an investor earns from purchasing a bond, while the bond price is the present value of all future cash flows that the bond will generate.

Bonds have a pre-determined maturity date at which the nominal value of the bond will be repaid to the investor. This characteristic makes bonds less risky than stocks because investors know the exact amount of money they will receive at maturity. Rating agencies assess bonds based on the issuer’s ability to repay interest and principal at maturity and assign them a rating. Ratings range from “AAA,” representing the highest degree of reliability, to “D,” indicating issuer default. Ratings are an important tool for investors as they provide an assessment of the issuer’s reliability and enable them to make informed decisions about their investments.

In summary, this market plays a fundamental role in the global economy as it allows companies and governments to obtain financing for their activities and enables investors to diversify their investment portfolios. Additionally, the bond market is closely related to central banks’ monetary policy, which regulates the benchmark interest rate for the economy. Consequently, investors often analyze bonds to gain a better understanding of future expectations.

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