Value Recap – The Importance of a Bond Market

 This article was first published on Jun 2014

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Most people would probably know what the stock market is, but what is little known yet critical to the development of an economy is the bond market.

 

A bond market is not just an environment where issuers and investors are brought together to allocate capital from savers to borrowers; it serves as a critical role to set interest rates and create credit. This directly affects the housing market, car sales and a corporation’s capital spending which would ultimately impact a country’s economic outlook. Rising interest rates tend to weaken the economy as cost of borrowing increases while falling interest rates tend to bolster an economy as it encourages borrowers to take up additional credit.

 

Interest rates are quoted on loans, mortgages, credit cards, saving accounts and money market funds which are linked to the bond market. The rates for these instruments are generally correlated with the interest rate level set in the bond market. For example, the SIBOR (Singapore Interbank Offered Rate) is a reference rate based on the interest rates used by banks to borrow/lend Singapore Government Securities (SGS) with each other; home loan packages are typically referenced from the SIBOR. In addition, the development of the Singapore bond market is essential as it allows the Government to meet the investment needs of the Central Provident Fund (CPF) through the issuance of Special Singapore Government Securities (SSGS). As at March 2013, total Singapore Government borrowings stood at S$396 billion, of which S$249 billion accounted for SSGS.

 

Financial instruments are linked to the bond market because it serves as a reference point or a benchmark indicating expected future interest rates in relation to different maturities. This is the term structure of interest rates or the yield curve. A government benchmark yield curve is built through the development of the SGD bond market, requiring a liquid (active trading) market consisting of a variety of Singapore Government Securities (SGS) in order to price debt securities as shown below:

 

Types of Singapore Government Securities

Treasury Bills
  • Short-term marketable government securities
  • Maturity of 1-year or less
Government Bonds
  • Fixed-rate securities with tenors in 2, 5, 10, 15, 20 and 30 years

Source: MAS Singapore Bond Market Guide 2012

 

Value Recap!

The bond market is useful for an investor to understand the economic outlook of a country; it directly impacts interest rate levels and the availability of credit in the economy. A government benchmark yield curve is essential in pricing of debt securities, requiring an active trading market consisting a variety of government securities.

 

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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie doesn’t own shares in any companies mentioned above.

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