Fixed Income

What is Bond?

Definition

A bond is a fixed-income security where the investor lends money to an issuer (government or corporation) for a defined period at a fixed or variable interest rate. Bonds pay periodic interest (coupons) and return the principal at maturity.

Detailed Explanation

Bonds are a fundamental asset class representing debt obligations. When you buy a bond, you are lending money to the issuer in exchange for regular interest payments (coupons) and the return of your principal (face value) at maturity.

Bond prices and yields move inversely. When interest rates rise, existing bond prices fall (their fixed coupons become less attractive). When rates fall, bond prices rise. This interest rate risk is measured by duration—longer-duration bonds are more sensitive to rate changes.

Bonds are classified by issuer type: government bonds (Treasuries, considered risk-free), municipal bonds (issued by state and local governments, often tax-exempt), corporate bonds (investment-grade and high-yield), and agency bonds (government-sponsored enterprises).

Bonds serve important portfolio functions: income generation, capital preservation, and diversification from stocks. During economic downturns and market stress, high-quality bonds often appreciate as investors flee to safety, providing a natural hedge for equity-heavy portfolios.

Frequently Asked Questions

Are bonds safer than stocks?

Generally yes, especially government bonds. Bonds have contractual interest payments and return principal at maturity. However, bonds can lose value when interest rates rise, and corporate bonds carry default risk. Over long periods, stocks have outperformed bonds.

How do interest rate changes affect bonds?

Bond prices move inversely to interest rates. When rates rise, existing bond prices fall. When rates fall, prices rise. Longer-maturity bonds are more sensitive to rate changes. This is the primary risk for bond investors.

What is the yield on a bond?

Current yield is the annual coupon divided by the bond's price. Yield to maturity (YTM) is the total return if held to maturity, accounting for price, coupons, and time. YTM is the most comprehensive yield measure.

Related Terms

Credit Rating

A credit rating is an assessment by a rating agency (S&P, Moody's, Fitch) of a borrower's ability to repay debt. Ratings range from AAA (highest quality) to D (default), with investment grade (BBB- or above) and speculative grade (BB+ or below) as the key dividing line.

Yield to Maturity (YTM)

Yield to maturity is the total return anticipated on a bond if held until it matures, expressed as an annual percentage. It accounts for the bond's current price, coupon payments, face value, and time to maturity, making it the most comprehensive bond yield measure.

Coupon Rate

The coupon rate is the annual interest rate paid by a bond's issuer relative to the bond's face value. A bond with a $1,000 face value and 5% coupon pays $50 per year in interest, typically in semiannual installments.

Duration

Duration measures a bond's sensitivity to interest rate changes, expressed in years. A duration of 5 means the bond's price will change approximately 5% for every 1% change in interest rates. Longer duration means more interest rate risk.

See It in Action

Apple

Microsoft

Johnson & Johnson

Berkshire Hathaway

Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.