3 Min WatchArticle17 Jul 2024

The Economics of Corporate Bond Markets

By Erik Norland

At a Glance

Typically, higher yield bonds have more correlation with equities, and investment grade bonds correlate with Treasuries

Corporate bond futures allow investors to more precisely manage risk

With futures launching on both investment grade and high yield corporate bonds, there are three things that investors should know about the economics of these markets.

Video Player is loading.

Current Time 0:00

Duration -:-

Loaded: 0%

Stream Type LIVE

Remaining Time 0:00

1. Correlations

U.S. corporate bonds inhabit a space in the investment landscape that is somewhere in between U.S. Treasuries and equities. Investment grade bonds, like those in the Bloomberg U.S. Corporate Bond Index, usually correlate highly with U.S. Treasuries. However, that correlation can dip during periods of market stress like during the global financial crisis and the onset of the pandemic. During these scenarios, having a future specific to the needs of corporate bond investors could help them to mitigate risk.

By contrast, high-yield bonds, such as those in the Bloomberg U.S. Corporate High Yield Very Liquid Index, usually correlate more strongly with the S&P 500 than with U.S. Treasuries.

2. Scalability

Futures allow investors to scale risk exposures up and down. For example, risk parity strategies can use futures to scale U.S. Treasuries up to equity-like levels of risk. Up until now, scaling the risk of corporate bonds up to equity-like risk has been difficult, and both Bloomberg indices have rather low historical volatilities compared to equities.

3. Optionality

Owning shares in a corporation is akin to owning call options on the value of a firm with a strike price of zero and no certain expiry. Unlike U.S. Treasuries, corporate bonds are not backed by the full faith and credit of the U.S. government. Instead, they depend on corporate cash flows to make good on their coupon and principal payments.

As such, corporate bonds are akin to being long a U.S. Treasury plus a short put option on the value of a corporation. Their common dependence on the financial health of corporations are what gives corporate bonds, and especially high yield corporate bonds, their higher correlation with equities and their imperfect correlation with U.S. Treasuries.

About the author

Erik Norland, Managing Director & Chief Economist, CME Group

is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their potential impact on CME Group's various asset classes, ranging from interest rate products to energy and agriculture. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical developments.

_{OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance and economics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.}

_{All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.. In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl). CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).}