What Is a Bond?
Let me tell you directly: a bond is a fixed-income investment that governments or corporations issue to raise money. When you buy one, you're essentially lending money to that entity at a set interest rate for a specific period. They'll pay you back the original amount, called the face value, plus interest. You can find these on most brokerage platforms.
Companies, municipalities, states, and governments use bonds to fund projects and operations. As a bond owner, you're a creditor to the issuer. The bond specifies the maturity date when the principal is due, along with terms for fixed or variable interest payments.
Key Takeaways
Understand this: a bond is a fixed-income tool that pays a set interest rate, or coupon, to holders, and you can buy them through major brokers. Bond prices go down when interest rates rise, and up when rates fall. They come with maturity dates, where the principal must be repaid fully, or the issuer risks default.
How Bonds Work
Bonds are debt instruments, representing loans you make to the issuer. As an individual investor, you step into the lender's role. Governments and corporations issue them to borrow for infrastructure like roads, schools, or dams. Companies might use the funds to expand, buy equipment, fund projects, research, or hire staff.
These are fixed-income securities, one of the core asset classes alongside stocks and cash equivalents. The issuer outlines the loan terms, interest payments, and maturity date for principal repayment. That interest is your return for lending the money, determined by the coupon rate.
Most bonds start at par value, their face value. But the market price fluctuates based on the issuer's credit quality, time to maturity, and how the coupon compares to current interest rates. At maturity, you get the face value back.
Fast Fact
Here's a key point: markets let you buy or sell bonds to other investors anytime after issuance, so you don't have to hold until maturity.
Characteristics of Bonds
Every bond has core traits you need to know. The face or par value is what you get at maturity, and it's used to calculate interest. The coupon rate is the percentage interest paid on that face value. Coupon dates are when those payments happen. The maturity date is when the principal is repaid. The issue price is what the bond sells for initially, often at par.
Bond Categories
There are four main types of bonds in the markets, plus foreign ones from global entities on some platforms. Corporate bonds come from companies preferring them over bank loans for better terms and lower rates. Municipal bonds are from states and cities, sometimes with tax-free income. Government bonds include U.S. Treasury bills (under a year), notes (1-10 years), and bonds (over 10 years), all called treasuries. Agency bonds are from government-linked groups like Fannie Mae or Freddie Mac.
Bond Prices and Interest Rates
Bond prices change daily based on supply and demand. If you hold to maturity, you get principal plus interest, but you can sell earlier where prices fluctuate. Prices move opposite to interest rates: up rates mean down prices, and vice versa.
For a fixed-rate bond, the issuer pays a coupon based on face value. Take a $1,000 par bond with 10% coupon: you get $100 yearly. If market rates are 10%, it's neutral. But if rates drop to 5%, your $100 is better than a new bond's $50, so the price rises to $2,000 to match yields. If rates hit 15%, the bond sells cheaper, say $666.67, to equalize.
Yield-to-Maturity (YTM)
YTM is the total return you can expect if you hold the bond to maturity, expressed annually. It's the internal rate of return assuming all payments are on schedule. You use it to compare bonds with different coupons and maturities. The formula solves for the rate.
To gauge price changes from interest rate shifts, use duration. It shows the price change for a 1% rate move— that's modified duration. Long-maturity or low-coupon bonds are most sensitive.
How to Invest in Bonds
You can access bonds through online or discount brokers, just like stocks. Buy Treasuries directly from TreasuryDirect. Or go indirect with fixed-income ETFs or mutual funds. Check lists of top online brokers for options.
Bond Variations
Bonds vary by interest type, recall options, or other features. Zero-coupon bonds pay no interest but are discounted, returning face value at maturity—like Treasury bills. Convertible bonds let you swap for stock under conditions. Callable bonds can be redeemed early by the issuer, riskier if values rise. Puttable bonds let you sell back early, useful if rates rise or values drop, making them pricier than similar non-puttable ones.
What Determines a Bond's Coupon Rate?
Credit quality and maturity time set the coupon rate. Poor credit means higher risk and higher interest. Longer maturities expose you to more interest and inflation risks, so they pay more.
How Are Bonds Rated?
Agencies like S&P, Moody’s, and Fitch rate bonds. Investment-grade are top quality, like U.S. government or stable firms. Junk bonds are lower grade, not defaulted, but riskier, so they offer higher coupons to compensate.
What Is Duration?
Duration measures how bond or portfolio values change with interest rates— not the time to maturity. It tells you the price sensitivity to rate shifts.
The Bottom Line
In summary, bonds let companies and governments finance projects and operations with fixed-interest payments to you as the debtholder. Buy them via brokers or directly from the Treasury.
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