Understanding Bonds and How They Work

A bond is essentially a loan: you lend money to a government or company, and in return they pay you regular interest and return your principal at maturity. Bonds are the backbone of fixed-income investing.

The key terms

• Face value — the amount repaid at maturity.
• Coupon rate — the fixed interest paid, as a % of face value.
• Maturity — when the principal is returned.
• Yield — your actual return given the price you paid, which moves inversely to price.

Why bond prices move

When market interest rates rise, existing bonds paying lower coupons become less attractive, so their prices fall — and vice versa. How sensitive a bond is to rate changes is measured by its duration. Longer-dated bonds swing more.

The two main risks

• Interest-rate risk — price falls if rates rise.
• Credit risk — the issuer may default; a bond’s credit rating signals this. Government securities have the lowest credit risk.

How to invest

Retail investors can buy bonds directly or, more simply, through debt and corporate bond funds that hold a diversified basket. Bonds add stability and income to a portfolio. Education only, not a recommendation.