Market segments and who issues

Three main ways to slice the market

Fixed-income markets are usually classified along three dimensions. Issuer type, also called sector: governments, companies, securitised vehicles and so on. Credit quality: how likely the issuer is to pay in full and on time. Time to maturity: how long until the principal is repaid.

Sometimes markets are also grouped by the issuer's geography (developed versus emerging markets, for example), the currency of the bond, or ESG characteristics such as whether issuers pass environmental or social screens.

A big contrast with stocks: a company typically has one or two classes of shares, but it can have dozens of debt instruments outstanding at once. It may have bank loans and bonds, short-term debt for working capital and long-term debt for capital projects, and issues in several currencies to hedge its exposures and reach more investors.

Credit quality and the rating scale

The usual gauge of credit quality is a credit rating: a letter grade from an agency such as S&P or Moody's that reflects both the chance of default and the expected loss if it happens. Agencies rate both short-term and long-term debt, and both issuers and individual bond issues.

On the S&P scale, AAA is the strongest, followed by AA, A and BBB. BBB− (Moody's Baa3) is the lowest investment-grade rating. From BB+ (Moody's Ba1) downwards, debt is called high yield, speculative grade or junk: BB, B, CCC, CC, C, and finally D for a payment default or bankruptcy filing.

Many investors may only buy rated debt, with a small allowance for unrated instruments, and many mandates are limited to investment grade. That makes the BBB−/BB+ boundary one of the most important lines in the bond market.

High-yield issuers come in two flavours. Some are newer or riskier businesses with less stable operating cash flows, so lenders tend to demand collateral. Others are fallen angels: companies that were investment grade when they issued but whose credit quality has since deteriorated.

Sovereign issuers

Within each market, the national government usually has the lowest credit risk, because it has the right to tax economic activity. Developed-market (DM) sovereigns often carry a AAA rating, and investors generally assume they will receive every promised payment. That is why DM government debt sits in the 'default risk free' row.

DM sovereign bonds are widely held abroad, including by foreign central banks that want reserves in that currency in an interest-earning form. At home, the central bank uses domestic government bonds to run monetary policy, lending or borrowing them to raise or lower the amount of reserves in the banking system.

Investment-grade versus high-yield corporate issuers

A strong investment-grade company can borrow unsecured at almost any maturity and in several currencies. It typically matches the term of its debt to what it is financing: commercial paper for short-term or seasonal working capital, intermediate-term notes for more permanent working capital or medium-term investment, and long-term bonds for long-lived assets such as plants and equipment.

Such issuers also pay a group (a syndicate) of banks for credit facilities: agreements with fixed terms and a limit, where the amount actually drawn goes up and down with the borrower's needs, much like a credit card. A short facility (often 364 days) commonly stands behind the commercial paper programme; a longer revolving credit facility provides backup funding.

A high-yield company with fewer fixed assets and less stable cash flows has much narrower access. It cannot use the unsecured commercial paper market and relies on secured working-capital and credit facilities from banks. Its term debt is often a bank term loan with a floating coupon (a market reference rate plus a fixed spread), and any bonds it sells often carry features such as a call option for the issuer.

Think of credit quality as a passport. The better the rating, the more segments (maturities, currencies, unsecured markets) the issuer can enter.