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.

Credit Market Participants

The government is the largest issuer of debt, issuing Treasury bills, notes and bonds, which have durations to maturity of anywhere from one month to 30 years. Corporations also issue corporate bonds, which make up the second largest portion of the credit market. In 2016, corporations issued $1.5 trillion in non-convertible corporate debt, a 2% increase from the previous year, and $18.8 billion in convertible debt, a 9.0% decline. Through corporate bonds, investors lend corporations money they can use to expand their business. In return, the company pays the holder an interest fee and repays the principal at the end of the term. Municipalities and government agencies such as Fannie Mae may also issue bonds. In 2016, U.S. municipalities issued $445.8 billion in municipal bonds, a 10.1% increase from the previous year. 

RELATED TERMS
  1. Bond Market

    The bond market is the environment in which the issuance and ...
  2. Bond

    A bond is a fixed income investment in which an investor loans ...
  3. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
  4. Debt Security

    A debt security is an instrument bought or sold between two parties ...
  5. Municipal Bond

    A municipal bond is a debt security issued by a state, municipality ...
  6. Combination Bond

    Combination bonds are municipal bonds with financial backing ...
Related Articles
  1. Retirement

    How to pick the right bonds for your IRA

    Learn about what types of bonds you may want to include in an IRA depending on risk tolerance. Understand the tax benefits of holding bonds in an IRA.
  2. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
  3. 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.
  4. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  5. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  6. Investing

    Why Muni Bonds and Bond Funds are Perfect Together

    Municipal bonds and bond funds differ in several ways, which is partly why they complement each other well.
  7. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
Trading Center