You can think of the fixed income markets like any other market which brings together buyers and sellers of a product. However, in this particular market (which is also called the "interest rate markets" or the "debt markets"), the product is money and its price is the interest rate at which buyers (i.e. the borrowers) are willing to pay sellers (i.e. the lenders) for that money.

The price of the money, i.e. the interest rate, is determined by a number of factors including demand and supply, the risk of the borrower defaulting on interest and repayment and the term of the loan.

Short-term and long term markets

The fixed income markets are broken down into two distinct segments. These are the short-term market (often called the money market) and the long-term market (often called the bond market). The distinction between these markets is important because different fixed income products are traded in each market according to the term to maturity and their own specific market conventions.

Most investors will invest in both markets and may even switch between them from time to time depending on their outlook for interest rates. Being able to accurately forecast future interest rates is a critical aspect of fixed income investing.

The money markets

The short-term market is often referred to as the "money markets". This is the market where instruments with maturities of up to 12 months are traded. Borrowers who are looking for cash for only short periods of time, i.e. up to 12 months, use this market to identify lenders who may have surplus cash to invest, again only for a short period of time. Banks play a major role in this very high volume market.

Products traded in the short term market are called "discount securities" because they are issued at a discount to their face value and the buyer receives the full face value on maturity. For example, a treasury note is purchased for $96.50 and on maturity, in 180 days time; the investor will receive $100, which would yield a return of 7.35% p.a.

You may notice that sometimes these short term securities will also be called instruments while long term products will be referred to as "securities". These terms are used interchangeably.

Common instruments include cash, treasury notes, promissory notes/commercial paper, bank bills, certificates of deposit and commercial bills.

The bond markets

The long-term market is often referred to as the "fixed interest or bond markets" and is where securities with maturities of one year or greater are traded. Another way to think of this is to see this market as the market for long-term loans.

Two types of securities are issued and traded. First, there are securities which pay a fixed rate of interest, for example, government bonds. Second, there are securities which have varying interest structures. These are often called "variable rate securities".

The different types of securities issued and traded in the Australian market include Commonwealth Government bonds, semi-government bonds, bank transferable certificates of deposit, corporate bonds, floating rate notes and bonds, asset backed securities and index linked securities.