What is the 'Credit Market'

Credit market refers to the market through which companies and governments issue debt to investors, such as investment-grade bonds, junk bonds and short-term commercial paper. Sometimes called the debt market, the credit market also includes debt offerings, such as notes, and securitized obligations, including mortgage pools, collateralized debt obligations (CDOs), dwarfs and credit default swaps (CDS).

BREAKING DOWN 'Credit Market'

The credit market dwarfs the equity market in terms of dollar value. As such, the current state of the credit market acts as an indicator of the relative health of the markets as a whole. Some analysts refer to the credit market as the canary in the mine, because the credit market typically shows signs of distress before the equity market.

How the Credit Market Works

When corporations, national governments and municipalities need to earn money, they issue bonds. Investors who buy the bonds essentially loan the issuers money. In turn, the issuers pay the investors interest on the bonds, and when the bonds mature, the investors sell them back to the issuers at face value. However, investors may also sell their bonds to other investors for more or less than their face values.

Other parts of the credit market are slightly more complicated, and they consist of consumer debt, such as mortgages, credit cards and car loans bundled together and sold as an investment. Simply, as the bank receives payments on the debt, the investor earns interest on his security, but if too many borrowers default on their loans, the investor loses.

Health of the Credit Market

Prevailing interest rates and investor demand are both indicators of the health of the credit market. Analysts also look at the spread between the interest rates on Treasury bonds and corporate bonds, including investment-grade bonds and junk bonds. Treasury bonds have the lowest default risk and, thus, the lowest interest rates, while corporate bonds have more default risk and higher interest rates. As the spread between the interest rates on those types of investments increases, it can foreshadow a recession.

Difference Between Credit and Equity Markets

While the credit market gives investors a chance to invest in corporate or consumer debt, the equity market gives investors a chance to invest in the equity of a company. For example, if an investor buys a bond from a company, he is lending the company money and investing in the credit market. If he buys a stock, he is investing in the equity of a company and essentially buying a share of its profits or assuming a share of its losses.

Why Investors Utilize the Credit Market

Simply, investors utilize the credit market in hopes of earning money. Bonds are considered to be safer investments than stocks, as they offer fixed-income earning potential, and if a company goes bankrupt, it pays its bondholders before its stockholders. To reduce their exposure of risk related to any single security, investors invest in mutual funds and exchange traded funds (ETF) that consist of a group of bonds.

RELATED TERMS
  1. Junk Bond

    A colloquial term for a high-yield or non-investment grade bond. ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Credit Risk

    The risk of loss of principal or loss of a financial reward stemming ...
  4. Debt Security

    Any debt instrument that can be bought or sold between two parties ...
  5. Credit Rating

    An assessment of the creditworthiness of a borrower in general ...
  6. Collateralized Bond Obligation ...

    An investment-grade bond backed by a pool of junk bonds. Junk ...
Related Articles
  1. Investing

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  2. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  3. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
  4. Investing

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  5. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  6. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  7. Investing

    Find Security In Covered Bonds

    Find out about a safe investing alternative that could have prevented the subprime meltdown.
  8. Investing

    The Pros and Cons of High-Yield Bonds

    Junk bonds are more volatile than investment-grade bonds but may provide significant advantages when analyzed in-depth.
  9. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
RELATED FAQS
  1. What are some classes I can take to prepare for the Series 6 exam?

    Learn about how the risk-return tradeoff applies to bond yields, and the different types of risks associated with investing ... Read Answer >>
  2. How do the returns on municipal bonds compare to those of other bonds?

    Learn how tax-free municipal bonds may provide better returns than other types of bonds, and understand the risks of municipal ... Read Answer >>
  3. What forms of debt security are available for the average investor?

    Discover the various different types of debt securities, issued by government entities or corporations, that are available ... Read Answer >>
  4. How important is credit rating on a fixed income security?

    Learn how credit ratings for fixed-income securities impact the yield and provide guidance for the amount of risk for the ... Read Answer >>
  5. Who are the key players in the bond market?

    The bond market can essentially be broken down into three main groups: issuers, underwriters and purchasers. The issuers ... Read Answer >>
  6. How are junk bonds rated differently by Standard & Poor's and Moody's?

    Learn how credit rating agencies rate bonds with junk bond status, and understand how downgrade risk can impact the price ... Read Answer >>
Hot Definitions
  1. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  2. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  3. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  4. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  5. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
  6. Hard Fork

    A hard fork (or sometimes hardfork) is a radical change to the protocol that makes previously invalid blocks/transactions ...
Trading Center