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The U.S. bond market is like the sport of baseball - you have to understand and appreciate the rules and strategies, or else it seems boring. It's also like baseball in that its rules and pricing conventions have evolved over time, and they sometimes seem as esoteric as the balk rule in baseball.
In the baseball Official Major League Rule Book, it takes more than 3,600 words to cover the rules of what the pitcher can and cannot do. In this article, we're going cover bond market pricing conventions in less than 2,000 words. Bond market classifications are briefly discussed, followed by yield calculations, pricing benchmarks and pricing spreads.A basic knowledge of these pricing conventions will make the bond market seem as exciting as the best World Series baseball game. (For related reading, check out the Bond Basics and Advanced Bond Concepts tutorials.)Bond Market Classifications
The bond market consists of a great number of issuers and types of securities. To talk about each specific type might fill an entire textbook; therefore, for the purposes of discussing how various bond market pricing conventions work, we make the following major bond classifications:
- U.S. Treasuries: Bonds issued by the United States Department of the Treasury.
- Corporate Bonds: Bonds issued by corporations that carry an investment grade rating.
- High-Yield Bonds: Also known as non-investment grade, or junk, bonds, these are bonds with a below investment grade rating.
- Mortgage-Backed Securities (MBS): A bond collateralized by the cash flows of principal and interest payments from an underlying pool of single family residential mortgages.
- Asset-Backed Securities (ABS): A bond collateralized by the cash flows of an underlying pool of assets such as auto loans, credit card receivables, home equity loans, aircraft leases, etc. The list of assets that has been securitized into ABSs is almost endless.
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