in general, to create a bond you conceivably need 3 entities:

1. an issuer (usually a company or government)
2. an attorney (to write and structure the bond contract)
3. an investment bank (to underwrite the sale, and find buyers for the securities)

usually, the broker will call up clients, mutual funds, or other banks, and recommend that they buy the new bonds for sale, frequently at a discount to par. this is why they are sometimes called "broker/dealers." sometimes the bank will buy the bonds for their own investment account.


there are a lot of different types of bonds (callable, convertible, etc.) so it's kind of hard to describe what happens after that. for simplicity, i'll just break them into two categories for now: liquid and illiquid.


illiquid bonds (normally corporates & junk) don't have many buyers or sellers in the market. so typically, these just stay in the custodial account at the buyer's brokerage firm (or a mutual fund, like PIMCO), and aren't traded. every quarter, the issuer sends a payment to each bond holder until maturity. when the bond matures, the issuer pays back their principal in full. in the past, most bonds have been illiquid.


liquid bonds (usually gov't or agency debt) enter the secondary market, aka the bond market, where they are bought and sold by various players. there are WAY more people interested in these bonds, so they are easier to buy and sell (in other words, more liquid). people still receive quarterly payouts, but they are really into leveraging and trading bonds like daytraders. whenever you see rick santelli on CNBC standing in a pit of traders at the CME, those are all bond traders (santelli and cramer are both former bond traders).

the profit comes from rising and falling interest rates: if rates rise, you profit by shorting bonds, and vice versa. remember, interest rate changes cause bond prices to fluctuate.

they make profits based on the volatility and movements of those rates. if interest rates remained still, they wouldn't make any money through trading, just through receiving bond payments. just like if stock prices remained the same, no one would make any money except for the dividend payments. it's the same process.