Two main factors determine the value of bonds and loans. One is the prevailing rate of interest – usually set by a central bank such as the US Federal Reserve or the European Central Bank. The interest paid on bonds or loans may rise or fall in line with prevailing interest rates or it may be fixed – in which case the value of the asset rises and falls as interest rates change. The other factor is credit risk, the risk that the borrower is unable or unwilling to make payments as they become due.
When the government of France or the United States issues bonds, the credit risk involved is minimal. What investors need to worry about is interest rates. But when companies or emerging market governments borrow, investors are exposed to both interest rate and credit risk.
The credit market, as defined in this primer, is the business of trading, structuring and investing in the credit risk of large companies, emerging market countries and structured finance bonds, either through cash instruments (bonds and loans) or through credit derivatives.