Different kinds of bonds like Govt. bonds, corporate bonds, municipal bonds, mortgage backed or asset backed bonds and others are traded in the Bond Market. The main participants of Bond Market are the individuals, govt. and the institutional investors. As bonds lack in liquidity unlike stocks, major amount of existing stocks of an economy generally lie in the hands of institutions like mutual funds, pension funds and banks.
Each bond comes with a maturity date. When the maturity period is over, the bond holder receives principal and interest according predetermined rates. But if a bon holder wishes to sell his bonds before completion of maturity period, his expected returns are subject to market risks. The risk generates from the fact that value of existing bonds fall when interest rate rises in the economy and the value of bonds rises when the interest rates falls. In every economy fluctuation in interest rates is an inevitable phenomenon as it is the obvious result of different monetary policies taken at different times as per requirement of the economy. So, the interest rates continue to change in every economy and as result Bond Market continue to be volatile in nature.
The main types of bonds are the following:
Fixed Rate Bonds- These bonds are associated with an interest rate which remains constant for the whole life of the bond.
Floating Rate Notes (FRN) - These are a kind of bonds which is related to money market index. Therefore interest rate associated with this kind of bond is changed periodically.
Zero Coupon Bond -Coupon means the interest rate that the issuer of the bond pays to the bondholder. So, Zero Coupon Bond is the bond, on which no interest is paid. After the maturity date, the bondholder receives the principal amount and the value that has accumulated up to the redemption date.
High Yield Bonds -These are the bonds which are associated with greater risk but expected to generate a higher yield.
Inflation Linked Bonds-In these types of bonds; principal amount is linked to inflation. Interest rates are lower than the Fixed Rate Bonds, but as the principal amount rises value of the bond rises with inflation.