You lend
You buy the bond at issue or on the market. That money goes to the issuer—a company, a government, or a local authority.
Lesson 02 · Markets
Introduction to bonds.
A bond is a loan you can buy. You lend money to a government or a company, they pay you interest along the way, and they return the amount borrowed on an agreed date. Everything else—coupon, maturity, yield, credit risk—describes the details of that one arrangement.
Back to all topicsFACE VALUE ✦ COUPON RATE ✦ MATURITY ✦ YIELD ✦ YTM ✦ CREDIT RISK ✦ CALLABLE ✦ CONVERTIBLE ✦ ZERO INTEREST
BEFORE YOU START
A bond is a loan, written down and traded.
Shares make you an owner. Bonds make you a lender. That single difference explains almost everything else about how they behave.
They pay interest
The issuer pays a coupon, usually a fixed percentage of the face value, on a regular schedule until the bond matures.
You are repaid
On the maturity date the issuer returns the face value. If the issuer cannot pay, that is credit risk—the main thing you are being paid to accept.
THE KEY TERMS
Six words that define every bond.
Every bond you will ever read about is described with the same handful of terms. Learn them once and the rest of the market becomes readable.
Means: The amount repaid to you at maturity.
Coupons are quoted as a percentage of face value, not of the price you paid.
In practice
A $1,000 bond repays $1,000 on its maturity date.
Means: The fixed interest the issuer pays to bondholders.
Set when the bond is issued and normally unchanged for the life of the bond.
In practice
A 5% coupon on a $1,000 bond pays $50 a year.
Means: When the principal is repaid and the bond ends.
Longer terms usually mean more sensitivity to interest rate changes.
In practice
A 10-year bond issued in 2026 matures in 2036.
Means: The return on the bond, which depends on the price you actually pay.
Two people holding the same bond can have different yields if they bought at different prices.
In practice
A $50 coupon on a bond bought for $950 yields 5.26%.
Means: The profit on the bond, paid out as coupons or built into the price.
Explicit interest arrives as payments. Implicit interest comes from buying below face value.
In practice
A bond bought at $600 that repays $700 pays its interest implicitly.
Means: A bond issue repaid in instalments across several maturity dates.
Instead of one repayment date, portions of the issue mature in sequence.
In practice
A municipal issue that repays a slice of the principal each year.
TYPES OF BONDS
Who is borrowing, and on what terms.
The first list sorts bonds by who issues them. The second sorts them by the conditions attached to the loan itself.
By issuer
- Corporate bonds
Issued by companies to fund operations, expansion, or refinancing.
Higher risk, higher expected return. - Government bonds
Issued by national governments—US Treasuries are the reference example.
Low risk, lower return. - Municipal bonds
Issued by local or state authorities to fund public projects.
Often carry tax advantages. - Junk / high-yield bonds
Issued by borrowers with weaker credit quality.
Riskier issuers, higher potential return.
By structure
- Secured bonds
The issuer pledges collateral, usually capital assets, against the debt.
Less risk to the lender, so lower interest rates. - Unsecured bonds
No collateral stands behind the promise to repay.
More risk, higher interest rates—most junk bonds sit here. - Convertible bonds
Can be exchanged for a set number of the issuer’s shares.
A $100 bond might convert into 15 shares of stock. - Callable bonds
The issuer can repay early by returning the principal plus interest.
The timing is the issuer’s choice, not yours. - Zero-interest bonds
No periodic payments; the bond is sold at a deep discount to face value.
Pay $600 today, receive $700 next year. - Commodity-backed bonds
Repayment can be made in commodities rather than cash.
Used by issuers whose revenue is tied to a physical resource. - Registered / bearer bonds
Registered bonds record a specific owner’s name; bearer bonds do not.
Whoever holds a bearer bond is treated as the owner.
RISKS OF BONDS
Safer than shares is not the same as safe.
Bonds carry four risks worth naming. None of them make bonds a bad idea—they explain why one bond pays more than another.
Interest rate risk
Bond prices fall when market interest rates rise.
Shorter maturities move less when rates change.Credit risk
The issuer may default and miss payments or repayment.
Government issuers are generally safer than weak corporate borrowers.Inflation risk
Rising prices reduce the real value of a fixed coupon.
A 5% coupon during 6% inflation loses purchasing power.Liquidity risk
Some bonds are hard to sell quickly at a fair price.
Widely traded government bonds are easier to exit than niche issues.YIELD
The coupon is fixed. The yield is not.
- Yield is the return on a bond investment, expressed as a percentage.
- It shows how much income you earn compared with the bond’s current market price.
- Yield to maturity (YTM) extends that calculation across the whole remaining term of the bond.
- Because it accounts for the price actually paid, yield is the “real” interest on the investment.
Worked example
Current yield = Annual coupon payment ÷ Market price- The bond
- $1,000 face value, 5% coupon
- Annual payment
- $50 a year
- Market price
- Trading at $950
- Current yield
- $50 ÷ $950 = 5.26%
HOW BONDS ARE PRICED
Rates up, prices down.
A bond’s coupon never changes, so the market adjusts the only thing it can: the price someone is willing to pay for it today.
Prices move inversely to interest rates
When new bonds are issued at higher rates, existing bonds with lower coupons become less attractive, so their prices fall until the yield is competitive.
Yield is the coupon divided by the price
The coupon is fixed, so every change in market price changes the yield. Pay less, earn more; pay more, earn less.
Higher yield signals higher perceived risk
When the market demands a bigger return from an issuer, it is pricing in a greater chance of not being paid back in full.
Bonds are financial instruments that let investors diversify a portfolio and act as a buffer against volatile markets.
A diversified portfolio matters because assets do not all fall at once. If the value of one holding drops, others can steady the overall position.
HOW TO USE THIS
Lending is a contract, not a bet.
- Read a bond as a contract: who is borrowing, how much they pay, and when the principal comes back.
- The coupon is fixed at issue, but the yield you earn depends on the price you pay for the bond.
- Rates and prices move in opposite directions, so a bond bought today can be worth less tomorrow without anyone defaulting.
- A higher promised return is compensation for risk, not a free upgrade—check who is issuing before chasing the yield.
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