Bond

What Is a Bond?

A bond is a debt security. When you buy one, you are lending money to the issuer, which is usually a government, a municipality, or a corporation. In return, the issuer agrees to pay you interest at fixed or variable intervals and to repay the original amount, called the face value or par value, when the bond matures. Bonds are often described as a way to borrow money from the public without taking on a bank loan.

How Bonds Work

Every bond has a few core features. The coupon is the stated interest rate, often paid in semiannual installments. The maturity date is when the issuer must return the face value. The issuer's credit quality determines how likely it is to make those payments on time. Bonds are sold at issue and then trade on secondary markets, where their prices move up and down.

Prices and interest rates tend to move in opposite directions. When market rates rise, existing bonds with lower coupons become less attractive, so their prices fall. When rates drop, those bonds typically become more valuable. Bonds with longer maturities usually react more strongly to these changes, a sensitivity measured by duration.

Example

Suppose a company issues a bond with a face value of 1,000 units and a 5 percent annual coupon, maturing in ten years. The holder would receive 50 units of interest each year and then 1,000 units back at maturity. If the holder sells before maturity, the sale price depends on current market conditions and the issuer's creditworthiness.

Advantages and Disadvantages

Bonds can provide predictable income and are often considered less volatile than stocks. They also rank higher than common shareholders in the event of bankruptcy. However, bond prices can fall when rates rise, and inflation can erode the purchasing power of fixed payments. Issuers can also default, meaning they fail to make promised payments. Credit rating agencies assess this risk, and lower-rated bonds generally offer higher yields to compensate investors for taking on more risk.

Why It Matters to Investors

Bonds are a major part of the global financial system and are widely used to diversify portfolios. Understanding a bond's yield to maturity, credit rating, and duration helps investors compare options and understand how their holdings might respond to changing economic conditions.