History of the United States’ Bond Market:
The history of bonds in the United States consists of multiple periods of issuance. The predominant bond markets in the United States are issued in the forms of corporate bonds, municipal bonds, and government bonds issued by the United States Treasury.
Bonds are issued by financial institutions and government bodies to raise money through the issuance of a “promise.” For a fee, an individual or corporation will purchase a bond from an issuing agency; the issuing agency will use the money to fund a project or carry-out an objective. In turn, the investor will receive his or her payment back plus interest once the bond reaches its maturity date.
The Beginning of the U.S. Treasury Bond Market
The United States Treasury began issuing bonds to help fund World War I. The efforts in the war were financed through an increase in taxation and through the sale of war bonds, known as “Liberty Bonds.” Individual citizens would purchase these liberty bonds from the government; citizens would pay the government a fixed rate in a loan format. After the government received payment they would promise repayment after the bonds matured.
Through the sale of Liberty Bonds, the United States government amassed over $21 billion dollars of debt that were paid out following the war. The surplus gathered from the issuance of the bonds; however, were not enough to cover the debt from the war, so the bonds were rolled over into bills (matured in less than one year), notes (matured in less than ten years) and government-issued bonds (matured in more than 10 years.) These bonds, notes, and bills were subsequently paid down regularly until borrowings increased during the Great Depression.
Changes in the United States Debt Market
Up until the great Depression, the United States Treasury Department issued subscription bonds, which were exchanged through the delivery of a coupon to the public and a maturity price of par. During this time, demand for foreign bonds grew exponentially, forcing the Treasury Department to institute an auction of notes.
The auction format enabled the yields in each maturity were used by the public to incorporate a risk-free investment strategy. As a result of this formation, other forms of bonds (such as municipal and corporate bonds) developed through a synthetic yield in proportion to credit considerations.
The Rise of Bonds
As the debt of the United States’ government grew, foreign governments became holders of the United States’ debt. The deficits, which rose during World War II and the Vietnam War, spawned a debt market and the increase of debt-related trading instruments between government bodies.
In the early 1980s, bond yields rose exponentially due to the increases in commodity prices, expanding deficits, and labor wage increases. Bond yields rise, because the market anticipates rising amounts of future debt; the need for funding becomes so dire that the issuing agencies will increase yields to spark investments. As a result of this, the yields of corporate credits will also rise, but are viewed as riskier investments when compared to government-issued bonds, which are guaranteed.
The Creation of Bond Derivatives
To better control risk, the financial markets instituted more-complex bonds, known as derivative securities. These instruments are legally created trusts that separate the maturity payment of the bond from the coupon. As a result, the interest rates attached to the bond have a singular value, separate from the bond itself. Thus, when interest rates rise, the interest-only portion of the bond will rise, while the principle of the bond will decline because the instrument is unlikely to be called early and the yield to maturity is re-set at the new interest rate. In turn, the corpus portion of the bond will be further discounted to reach a market yield; these forms of investments are complex and are typically combined with other securities to mitigate risk but maintain an expected return.