Bond
A bond is a loan to a government or company. The issuer usually pays regular interest (the coupon) and repays the face value at maturity. Bond prices move opposite to interest rates: when yields rise, existing bonds lose value.
When you buy a bond you become a lender. The borrower — a government, city or company — promises to pay you interest and to hand back the original amount on a set date. Bonds are the steady, income-paying side of most portfolios, but they still carry risks, above all from changing interest rates and from borrowers who cannot pay. This entry explains how a bond works from purchase to maturity and why its price moves.
- Category
- Bonds and Interest Rates
- Reading time
- 5 min
- Also called
- Bonds, Fixed income, Debt security
- Updated
Bonds in plain words
A bond is a debt security — essentially an IOU. Buying one means lending to the issuer, which can be a government, a municipality or a company.1
In return the issuer pays a stated rate of interest during the bond's life and repays the principal, also called face or par value, when the bond matures.1 Most bonds have their maturity date fixed at issue.2
Bond prices also move: when interest rates rise, prices of existing bonds tend to fall, and the reverse.2
A bond's life, step by step
The issuer borrows
A government or company sells bonds to raise money for a set period.
Terms are fixed
Face value, coupon rate and maturity date are set at issue. See Coupon Rate.
You collect interest
Coupons are typically paid on a schedule, often every six months.1
The price moves in between
If market rates change, the bond's price adjusts so its yield matches. See Yield to Maturity.
You can sell before maturity
At whatever the market price is then — above or below what you paid.
Maturity
The issuer pays the last coupon and the face value, and the bond ends.2
Worked examples
Example 1 — Holding to maturity
+$200 interestYou buy a 5-year bond at its face value of $1,000 with a 4% annual coupon, paid twice a year, and hold it to the end.
| Each coupon | 4% × $1,000 ÷ 2 = $20 |
| Coupons over 5 years | 10 × $20 = $200 |
| Repaid at maturity | $1,000 |
| Total received | $1,200 |
A bond held to maturity pays its scheduled interest and then the face value, provided the issuer does not default.1
Example 2 — Rates rise, the price falls
Price fallsA year later, new bonds of the same quality pay 6%. Your 4% bond, with four years left, now sells for about $930.
| Bought at | $1,000 |
| Market price now | ≈ $930 |
| Paper loss if sold | ≈ −$70 |
When interest rates rise, prices of existing bonds tend to fall.2 Holding to maturity still returns the full $1,000.
Example 3 — Rates fall, the price rises
Price risesInstead, rates of similar bonds drop to 3%. Your 4% bond, with four years left, now sells for about $1,037.
| Bought at | $1,000 |
| Market price now | ≈ $1,037 |
| Gain if sold | ≈ +$37 |
Falling rates lift the prices of existing bonds, because their fixed coupons now look more attractive.2
Bonds vs stocks
| Aspect | Bond | Stock |
|---|---|---|
| What you own | A loan to the issuer | Part of the company |
| Income | Scheduled interest | Dividends, if paid |
| At the end | Face value repaid | No end date |
| Price swings | Usually smaller | Usually larger. See Stock |
Why investors hold bonds
Advantages and disadvantages
Advantages
- Regular, predictable interest payments.
- Face value is repaid at maturity unless the issuer defaults.
- Usually less volatile than stocks.
- Government bonds are among the safest assets.
Disadvantages
- Prices fall when interest rates rise. See Duration.
- Issuers can default. See Default Risk.
- Fixed coupons lose real value to Inflation.
- Lower long-run returns than stocks.
Going deeper
Read as far as you need. Each level builds on the one before it.
Who issues bonds
Beginner
Companies, governments, federal agencies and other organisations issue bonds to raise capital, agreeing to pay interest in return.2 Government bonds such as Treasury Bills, Notes and Bonds are seen as safest; company bonds pay more for extra risk. See Corporate Bonds.
Why price and yield move opposite
Intermediate
A bond's coupon is fixed, so when new bonds offer higher rates, an old bond's price must drop until its yield matches the market.2 The longer the bond, the bigger that price move. See Duration and Yield Curve.
Credit risk and spreads
Advanced
Investors demand extra yield over government bonds for the chance a borrower cannot pay — the Credit Spread. Credit ratings summarise that risk, and spreads widen when investors fear defaults.
Common mistakes
Thinking bonds cannot lose money
Prices fall when rates rise, and issuers can default.
Confusing coupon and yield
Your return depends on the price you pay. See Current Yield.
Ignoring inflation
A 3% coupon with 4% inflation loses purchasing power. See Real Yield.
Chasing the highest yield
Higher yields usually mean higher risk of default.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A bond is a loan to a government or company.
- It pays interest and returns the face value at maturity.
- Bond prices move opposite to interest rates.
- Default and inflation are the other main risks.
- Bonds usually swing less than stocks and add stability.
Frequently asked questions
Can I lose money on a bond?
What is a bond's face value?
Are bond funds the same as bonds?
Further learning
- Coupon Rate
The interest a bond pays.
- Yield to Maturity
The full return on a bond.
- Duration
How sensitive a bond is to rates.
- Treasury Bills, Notes and Bonds
The benchmark government bonds.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Investor.gov (SEC). Bonds – FAQs (opens in a new tab) Checked .
- FINRA. Bonds (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.