What Is a Bond?
Bond Definition
A bond is a type of loan made by an investor to a government, corporation, or other organization. When you buy a bond, you are lending money to the issuer in exchange for:
- Regular interest payments, and
- The return of your principal when the bond matures
Bonds are considered fixed‑income investments because they typically pay a predictable stream of interest.
Why Bonds Matter
Bonds play a major role in global finance because they provide:
- Stable income through interest payments
- Lower volatility than stocks
- Diversification in investment portfolios
- Funding for governments and corporations
Governments use bonds to build infrastructure, fund programs, and manage budgets. Companies use bonds to expand operations, refinance debt, or invest in growth.
How Bonds Work
1. The Issuer Borrows Money
The issuer (government or company) sells bonds to raise cash.
2. The Investor Receives Interest
The issuer pays interest — called the coupon — usually every 6 months or annually.
3. The Bond Matures
At maturity, the issuer repays the face value (principal) to the investor.
Key Bond Terms
Face Value (Par Value)
The amount the bond will be worth at maturity, usually $1,000 per bond.
Coupon Rate
The interest rate the bond pays.
Example: A 5% coupon on a $1,000 bond pays $50 per year.
Maturity Date
The date the issuer must repay the principal.
Yield
The investor’s actual return, which can differ from the coupon rate if the bond’s price changes.
Credit Rating
A measure of the issuer’s ability to repay the bond. Ratings range from AAA (highest) to junk (highest risk).
Types of Bonds
1. Government Bonds
Issued by national governments. Examples:
- U.S. Treasury bonds
- U.K. gilts
- Japanese government bonds
These are typically the safest.
2. Corporate Bonds
Issued by companies. Higher risk than government bonds, but higher yields.
3. Municipal Bonds
Issued by cities, states, and local governments. Often offer tax advantages.
4. Zero‑Coupon Bonds
Pay no periodic interest. Sold at a discount and mature at full value.
How Investors Make Money from Bonds
1. Interest Payments
The primary source of income.
2. Price Appreciation
Bond prices rise when interest rates fall.
3. Holding to Maturity
You receive the full face value at the end of the bond’s term.
Why Bond Prices Move
Bond prices and interest rates move in opposite directions.
- When interest rates rise, bond prices fall
- When interest rates fall, bond prices rise
This relationship is one of the most important concepts in fixed‑income investing.
Example (Simplified)
You buy a $1,000 bond with a 4% coupon.
- You receive $40 per year in interest
- At maturity, you get your $1,000 back
If interest rates fall to 2%, your 4% bond becomes more valuable and its price rises.
Key Takeaways
- A bond is a loan from an investor to a government or company.
- Bonds pay interest and return principal at maturity.
- They are generally safer and less volatile than stocks.
- Bond prices move inversely to interest rates.
- Bonds provide income, stability, and diversification.