Bonds and Interest Rates

• Treasury Bills, Notes and BondsBeginner4 min read

  US Treasury securities are debt issued by the US government. Bills mature in a year or less and are sold at a discount; notes mature in 2 to 10 years and bonds in 20 or 30 years, both paying interest every six months.

• Yield to MaturityIntermediate4 min read

  Yield to maturity is the annual return you would earn by buying a bond at today’s price and holding it to maturity, assuming every payment is made and coupons are reinvested at the same rate. It is the standard way to compare bonds.

• Current YieldBeginner4 min read

  Current yield is a bond’s annual coupon divided by its current price. A bond paying $40 a year and trading at $950 has a current yield of about 4.2%. It ignores any gain or loss at maturity.

• Zero-Coupon BondIntermediate4 min read

  A zero-coupon bond pays no regular interest. It is sold below face value and repaid at full face value at maturity; the difference is the investor’s return. Its price is very sensitive to interest-rate changes.

• Callable and Putable BondsIntermediate4 min read

  A callable bond lets the issuer repay it early, usually when rates have fallen — bad for the investor, so callable bonds offer higher yields. A putable bond lets the investor sell it back to the issuer early, which protects the investor and usually means a lower yield.

• Credit SpreadIntermediate4 min read

  A credit spread is the extra yield a bond pays over a comparable government bond. It compensates investors for default risk and lower liquidity; widening spreads signal rising worry about borrowers.

• Coupon RateBeginner4 min read

  The coupon rate is the annual interest a bond pays as a percentage of its face value. A $1,000 bond with a 4% coupon pays $40 a year, whatever its market price.

• Default RiskBeginner3 min read

  Default risk is the chance that a borrower fails to make interest or principal payments on time. Credit ratings and credit spreads are the most common ways markets express it.

• Treasury Inflation-Protected SecuritiesIntermediate4 min read

  TIPS are US Treasury bonds whose principal rises and falls with the consumer price index. The fixed coupon is paid on the adjusted principal, so the interest payments also rise with inflation.

• DurationAdvanced4 min read

  Duration measures how sensitive a bond’s price is to interest rates. Modified duration gives the approximate percentage price change for a one-percentage-point change in yield: a bond with a duration of 7 loses about 7% if yields rise by 1 point.

• Real YieldIntermediate4 min read

  A real yield is a bond yield after inflation. It can be calculated from expected inflation, or observed directly in inflation-protected bonds such as TIPS. Rising real yields tend to weigh on gold and long-duration growth stocks.

• Breakeven InflationAdvanced3 min read

  Breakeven inflation is the yield on a regular government bond minus the yield on an inflation-protected bond of the same maturity. It is the inflation rate at which both would earn the same, and is used as a market estimate of expected inflation.

• Fallen Angels and Rising StarsIntermediate4 min read

  A fallen angel is a bond downgraded from investment grade (BBB− or above) to high yield. A rising star is the opposite: a high-yield bond upgraded to investment grade. Both can see forced buying or selling by funds with rating limits.

• Yield to WorstAdvanced4 min read

  Yield to worst is the lowest yield a bond can deliver if the issuer exercises its right to redeem early on the least favourable date for the investor. For callable bonds it is a more cautious figure than yield to maturity.

• 2s10s SpreadIntermediate4 min read

  The 2s10s spread is the 10-year government bond yield minus the 2-year yield. When it turns negative, the yield curve is inverted; in the US, inversions have often preceded recessions, though the timing has varied widely.

• ConvexityAdvanced4 min read

  Convexity describes how a bond’s duration changes as yields change. Because of convexity, an ordinary bond’s price rises more when yields fall than it drops when yields rise by the same amount.

• Loss Given DefaultAdvanced4 min read

  Loss given default is the share of an exposure that is lost if a borrower defaults. It is one minus the recovery rate: if lenders recover 40 cents on the dollar, the loss given default is 60%.

• Exposure at DefaultAdvanced4 min read

  Exposure at default is the amount a lender expects to be owed at the moment a borrower defaults, including undrawn credit lines that may be used before then. Expected loss is often estimated as probability of default × loss given default × exposure at default.

• Maturity WallIntermediate4 min read

  A maturity wall is a large amount of debt coming due around the same period. If interest rates are higher than when the debt was issued, refinancing it can be expensive or difficult for weaker borrowers.

• DV01 and CS01Advanced4 min read

  DV01 is the money gained or lost on a bond position if yields move by one basis point (0.01%). CS01 is the same idea for a one-basis-point change in the credit spread. Traders use them to size and hedge interest-rate and credit risk.

• Distressed DebtAdvanced3 min read

  Distressed debt is the bonds or loans of companies in, or close to, financial trouble or bankruptcy. It trades at deep discounts, and specialist investors buy it hoping for recovery or influence in a restructuring.

• SOFRAdvanced4 min read

  SOFR, the Secured Overnight Financing Rate, is a benchmark for the cost of borrowing US dollars overnight against Treasury collateral. It is published daily by the Federal Reserve Bank of New York and replaced USD LIBOR in most contracts.

• Credit Default SwapAdvanced4 min read

  A credit default swap is a contract in which one party pays a regular premium and the other agrees to compensate it if a named borrower suffers a credit event such as default. The annual premium, the CDS spread, is a market gauge of that borrower’s credit risk.

• Mortgage- and Asset-Backed SecuritiesAdvanced4 min read

  Mortgage-backed securities pool home loans and pass the borrowers’ payments to investors. Asset-backed securities do the same with other loans, such as car loans, credit cards or student loans. Early repayment by borrowers is a key risk.

• Green, Social and Sustainability-Linked BondsIntermediate4 min read

  Green and social bonds raise money for specified environmental or social projects. Sustainability-linked bonds work differently: the money can be used for anything, but the coupon changes if the issuer misses agreed sustainability targets. Labels follow voluntary guidelines, so the details vary.

• GreeniumAdvanced4 min read

  Greenium is the possible price premium — and so lower yield — of a green bond compared with an otherwise similar conventional bond from the same issuer. Studies disagree on how large it is, and it is often small or absent.

• Z-Spread and Option-Adjusted SpreadAdvanced4 min read

  The Z-spread is the constant spread that, added to the government spot-rate curve, makes a bond’s discounted cash flows equal its price. The option-adjusted spread goes further and uses a model to remove the effect of embedded options such as call rights.

• BondBeginner5 min read

  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.

• Yield CurveIntermediate4 min read

  The yield curve plots the yields of bonds from the same issuer, usually a government, from short to long maturities. It normally slopes upward; when short-term yields rise above long-term ones the curve is inverted, which has often come before US recessions.

• Risk-Free RateBeginner4 min read

  The risk-free rate is the return on an investment treated as having no default risk, usually proxied by short-term government bills such as US Treasury bills. It is the baseline every riskier investment must beat and a key input in CAPM, the Sharpe ratio and valuation.

Each term is defined in one sentence. Terms marked “Article in preparation” will get a full step-by-step article.

• Accrued Interest

  IntermediateArticle in preparation

  Accrued interest is the interest a bond has earned since its last coupon payment. When you buy a bond between coupons you pay the quoted (clean) price plus accrued interest, which together make the dirty price.

• Agency Bonds

  IntermediateGlossary

  Agency bonds are issued by US government-sponsored enterprises and agencies, such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks. They usually yield a little more than Treasuries because most lack an explicit government guarantee.

• Basis Pointbp · bps · bips

  BeginnerArticle in preparation

  A basis point is one hundredth of a percentage point, or 0.01%. A rate rise from 4.00% to 4.25% is 25 basis points; using basis points avoids confusion between a change of one percentage point and one percent.

• Bid-to-Cover Ratio

  IntermediateGlossary

  The bid-to-cover ratio divides the amount bid at a bond auction by the amount actually sold. A ratio of 2.5 means bids were two and a half times the offering; a weak ratio at a Treasury auction can push yields up because demand looked thin.

• Bond Ladder and Barbell

  IntermediateGlossary

  A bond ladder spreads money across bonds maturing in different years, so some cash comes back regularly to reinvest. A barbell instead holds only very short and very long bonds, skipping the middle, to mix safety with higher long-term yields.

• Certificate of DepositCD

  BeginnerGlossary

  A certificate of deposit is a bank deposit locked for a fixed term at a fixed interest rate, with a penalty for withdrawing early. In the US, CDs at insured banks are covered by FDIC insurance up to the legal limit.

• Collateralized Debt ObligationCDO · CLO

  AdvancedGlossary

  A collateralised debt obligation pools loans or bonds and slices the cash flows into tranches, from safest to riskiest. CDOs built on subprime mortgages were central to the 2008 crisis; collateralised loan obligations (CLOs) apply the idea to corporate loans.

• Commercial Paper

  IntermediateGlossary

  Commercial paper is short-term, unsecured debt issued by companies to fund day-to-day needs, usually maturing within a few months (at most 270 days in the US). Money market funds are major buyers.

• Contingent Convertibles (CoCos)AT1

  AdvancedGlossary

  Contingent convertible bonds, or CoCos, are bank bonds that turn into shares or are written down if the bank's capital falls below a trigger. They pay high coupons for that risk — Credit Suisse's AT1 bonds were wiped out in its 2023 rescue.

• Convertible Bonds

  AdvancedGlossary

  A convertible bond can be swapped for a set number of the issuer's shares. Investors accept a lower coupon in exchange for the chance to share in a rising stock price, while keeping the bond's repayment if the shares do poorly.

• Corporate Bonds

  BeginnerArticle in preparation

  Corporate bonds are loans to companies. They pay more than government bonds to make up for the risk that the company cannot pay, and that extra yield — the credit spread — widens when investors worry about defaults.

• Credit Rating

  BeginnerArticle in preparation

  A credit rating is an agency's opinion of how likely a borrower is to repay its debt. The main agencies — S&P Global, Moody's and Fitch — use scales from AAA (strongest) down to D (in default); downgrades usually push bond prices down.

• Debentures

  IntermediateGlossary

  In the US, a debenture is a bond backed only by the issuer's general creditworthiness, not by specific assets. In the UK the word can also describe secured debt, so check what a particular debenture is actually backed by.

• Debt Seniority

  IntermediateGlossary

  Seniority sets who is repaid first when a company fails: secured lenders, then senior unsecured bonds, then subordinated debt, then preferred shares, and common shareholders last. Junior debt pays more because it recovers less in a default.

• Eurobond

  AdvancedGlossary

  A Eurobond is a bond issued outside the country whose currency it uses — for example a dollar bond sold to investors in London. The name has nothing to do with the euro; the market lets borrowers reach international investors in a currency of their choice.

• Eurodollars

  AdvancedGlossary

  Eurodollars are US dollar deposits held at banks outside the United States. Eurodollar futures were for decades among the world's most traded contracts, until they were replaced by SOFR futures in 2023.

• Floating-Rate NotesFRN

  IntermediateGlossary

  Floating-rate notes pay a coupon that resets regularly to a benchmark rate such as SOFR plus a fixed margin. Because the coupon tracks current rates, their prices barely move when rates change — the opposite of long fixed-rate bonds.

• Forward Rate AgreementFRA

  AdvancedGlossary

  A forward rate agreement locks in an interest rate for a future period. At the start of that period, the two sides settle in cash the difference between the agreed rate and the market rate on a notional amount.

• Gilts

  IntermediateGlossary

  Gilts are bonds issued by the UK government. They are the UK's equivalent of US Treasuries, and index-linked gilts adjust their payments for inflation.

• High-Yield Bonds

  IntermediateArticle in preparation

  High-yield bonds, or junk bonds, are rated below investment grade. They pay higher interest to compensate for a higher risk of default, and their prices tend to move more like stocks than like government bonds.

• Investment Grade

  BeginnerArticle in preparation

  Investment grade describes bonds rated BBB− or higher by S&P and Fitch, or Baa3 or higher by Moody's. Many funds and insurers may only hold investment-grade debt, so falling below that line can force selling.

• LIBOR

  IntermediateGlossary

  LIBOR was the benchmark interest rate at which banks said they could borrow from each other, used to price trillions in loans and derivatives. After a rate-rigging scandal it was phased out, with publication of almost all settings ending by 2023; SOFR and SONIA replaced it.

• Municipal Bonds

  IntermediateGlossary

  Municipal bonds are issued by US states, cities and other local governments to fund public projects. Their interest is often exempt from federal income tax, which is why they appeal to investors in high tax brackets.

  Rules differ between countries; this is general information, not tax or legal advice.

• On-the-Run Treasuries

  AdvancedGlossary

  On-the-run Treasuries are the most recently issued bonds of each maturity; they are the most liquid and the prices most often quoted. Older off-the-run issues trade a little less and usually yield slightly more.

• Par Value

  BeginnerArticle in preparation

  Par value is a bond's face value — the amount repaid at maturity, often $1,000 or quoted as 100. A bond trading at 98 is below par, at 102 above par. For shares, par value is a nominal legal figure with little meaning.

• Perpetual Bonds

  AdvancedGlossary

  Perpetual bonds have no maturity date: they pay interest indefinitely unless the issuer chooses to redeem them. With no principal repayment in sight, their prices are very sensitive to interest rates; many bank capital bonds are perpetual.

• Prepayment Risk

  AdvancedGlossary

  Prepayment risk is the chance that borrowers repay early — usually when rates fall — so holders of mortgage-backed securities or callable bonds get their money back just when it can only be reinvested at lower rates.

• Primary Dealer

  AdvancedGlossary

  Primary dealers are about two dozen banks and broker-dealers that trade directly with the New York Fed and must bid at every Treasury auction. They act as the core market makers in US government bonds.

  Rules differ between countries; this is general information, not tax or legal advice.

• Prime Rate

  BeginnerGlossary

  The prime rate is the base interest rate US banks charge their most creditworthy customers, and many consumer loans are priced as prime plus a margin. By convention it sits three percentage points above the top of the fed funds target range.

  Rules differ between countries; this is general information, not tax or legal advice.

• Reinvestment Risk

  IntermediateGlossary

  Reinvestment risk is the chance that coupons or repaid principal can only be reinvested at lower rates than before. It bites when rates fall and is why callable bonds, which issuers redeem early in that situation, pay more.

• Repo Market

  AdvancedArticle in preparation

  In a repurchase agreement, or repo, one party sells securities — usually government bonds — and agrees to buy them back shortly after at a slightly higher price, which makes it a short-term loan backed by collateral. Repo funds much of the financial system; spikes in repo rates, as in September 2019, signal cash shortages.

• Subprime

  BeginnerGlossary

  Subprime describes loans to borrowers with weak credit histories, charged higher rates for the extra risk. Bundles of subprime mortgages turned into securities were at the heart of the 2007–08 financial crisis.

• TED Spread

  AdvancedGlossary

  The TED spread was the gap between the 3-month LIBOR rate and the 3-month US Treasury bill yield. It widened when banks distrusted each other, peaking in the 2008 crisis, and lost its basis when LIBOR was retired.

• Yankee Bonds

  AdvancedGlossary

  Yankee bonds are dollar-denominated bonds issued in the US by foreign companies or governments and registered with US regulators. Similar names exist elsewhere, such as Samurai bonds in Japan and Bulldog bonds in the UK.