Investing Basics · definition
Bond
A bond is a loan in security form: the buyer lends money to a government or company, which promises to pay periodic interest and return the principal on a set maturity date.
A bond is a tradable loan. The buyer of a bond lends money to the issuer, a government, municipality or company, which promises to pay interest (the coupon) on a schedule and to repay the face value when the bond matures. Unlike a shareholder, a bondholder owns a claim on payments, not a piece of the business: no votes, no share of profits, but a contract that ranks ahead of equity if things go wrong.
Bonds are the quiet giant of finance: the global bond market is larger than the global stock market, and the prices set there, above all on Treasury securities, become the reference rates for mortgages, pensions and company valuations everywhere.
Key takeaways
- A bond is debt: the investor is the lender, the issuer is the borrower.
- Bonds pay coupons and return face value at maturity; everything between issue and maturity trades at market prices.
- Bond prices move inversely to market interest rates, mechanically.
- Credit ratings grade the likelihood of being paid; "investment grade" and "high yield" are the two big leagues.
- Even high-quality bonds can have terrible years: 2022 was the worst on record for broad bond indexes.
The world's oldest cash flow
Bonds predate stocks. City-states of medieval Italy borrowed from citizens; the Dutch water authority Hoogheemraadschap Lekdijk Bovendams issued a perpetual bond in 1648 that still pays interest today (Yale University owns one and collects the coupons as a curiosity). The historical point survives in modern form: a bond is a promise written down, and well-drafted promises can outlive everyone who signed them.
Anatomy of a bond
Every bond is defined by a handful of terms: face value (the amount repaid at maturity, classically $1,000), the coupon rate (annual interest as a percentage of face value), the maturity date, and the issuer. A 10-year bond with a 4% coupon pays $40 a year, usually in two instalments, then returns $1,000. Variations exist for nearly every term: zero-coupon bonds skip the coupons entirely, floating-rate notes reset their coupon with market rates, inflation-linked bonds index the principal to consumer prices, and perpetuals never mature.
| Bond family | Issuer | Typical risk profile |
|---|---|---|
| Government (Treasuries, Bunds) | National states | Lowest credit risk in own currency |
| Municipal / agency | Local governments, public bodies | Low, varies by issuer |
| Investment-grade corporate | Established companies | Moderate credit spread |
| High-yield ("junk") | Riskier companies | Equity-like swings, higher coupons |
| Inflation-linked (TIPS) | Mostly governments | Protects purchasing power, not price |
The seesaw: prices and yields
After issue, bonds trade between investors, and their prices respond chiefly to interest rates. The logic fits in one example: you hold a bond paying 4% while newly issued bonds pay 5%. Nobody will pay full price for your 4% anymore, so its price falls until its effective return at the new price (its yield) matches the market. Rates up, prices down; rates down, prices up. The longer the bond's remaining life, the harder the swing, a sensitivity measured as duration: a bond with duration 7 loses roughly 7% of its price when rates rise one percentage point.
2022 made the textbook visceral: as central banks raised rates at the fastest pace since the 1980s, the broad US bond index (Bloomberg Aggregate) lost about 13%, its worst year since records began in 1976, and long-dated Treasuries lost far more. Nothing defaulted; the seesaw simply moved.
Credit: the other risk
The second risk is default, the issuer failing to pay. Rating agencies (Moody's, S&P, Fitch) grade issuers from AAA down through BBB- (the investment-grade floor) into the speculative grades, and markets price the risk as a credit spread above government yields. The history of sovereign and corporate defaults, from Argentina's repeated restructurings to Greece's 2012 haircut (private bondholders lost roughly half their claim, the largest sovereign restructuring in history), demonstrates that "bonds" and "safe" are not synonyms; seniority improves recovery, it does not guarantee it.
Between rate risk and credit risk sits a quieter one: inflation erodes the purchasing power of every fixed payment, which is precisely the problem inflation-linked bonds were invented to address.
Where bonds sit in portfolios
Descriptively, bonds appear in portfolios for three properties: steadier income, lower volatility than equities, and imperfect correlation with stocks (they often, not always, rise when equities fall; 2022 was the exception that disciplines the rule). The classic balanced templates described under asset allocation combine the two for exactly these reasons. What mix suits whom is a suitability question for an adviser.
Frequently asked questions
Are bonds safer than stocks?
Bondholders rank ahead of shareholders and bond prices usually swing less, but bonds carry interest-rate, inflation and credit risk, and 2022 showed double-digit losses are possible in high-quality bonds. "Safer on average" is the defensible phrasing.
What happens if I hold a bond to maturity?
You receive the promised coupons and face value, assuming no default, regardless of the price swings along the way. The swings only become losses if you sell into them.
Why do bond funds behave differently from individual bonds?
A fund holds many bonds and never "matures"; it continuously rolls positions, so its value tracks market prices indefinitely. The trade-off between owning bonds directly and through funds (including ETFs) is structure, not magic.
Sources
This entry is for education only. Investing Value describes how financial concepts work; it does not provide investment, tax or legal advice, and nothing here is a recommendation to buy or sell any asset.