Credit Market

Reviewed by Apoorva | Updated on Aug 26, 2020

Introduction

Credit market, also known as debt market, is a market where companies and governments offer debt to investors in he form of junk bonds, investment-grade bonds, and short-term commercial paper. It includes debt offerings such as notes and securitised obligations such as collateralised debt obligations (CDOs), credit default swaps (CDS), and mortgage-backed securities.

The status of credit market indicates the collective health of the markets and economy. The credit market seems tiny as compared to the equity market in terms of dollar value. Analysts describe credit market as the canary in the mine because the credit market shows signs of distress before the equity market does.

Understanding Credit Market

When a government entity needs to earn money, they issue bonds. Investors buy bonds in exchange for loaning money to the issuer. The issuer pays interest on the bonds to the investors. Upon bond maturity, the investors sell the binds back to the issuer at face value. It is also possible that investors sell bonds to other investors prior to maturity.

There are other aspects of the credit market that consist of consumer debts such as credit cards, mortgages, and car loans. These aspects make it complicated to deal with. They receive payments on bundled debt and sell as an investment known as bundled debts. The buyer earns interest on the security. If many borrowers default on their loans, the buyer loses money.

There are two indicators of the health of the credit market—prevailing interest rates and investor demand. Analysts consider the spread between the interest rates on treasury bonds and corporate bonds. It includes investment-grade bonds and junk bonds.

Treasury bonds, usually, have the lowest default risk and the lowest interest rates, while corporate bonds have higher interest rates and more risk by default. As the spread between the interest rates on those types of investments increases, it can foreshadow a recession investors are viewing corporate bonds as increasingly risky.