What is a Bond?

A bond is a loan you make to a government, public agency, or company. The issuer pays you interest on a set schedule, usually twice a year, and repays the full face value on a fixed date called the maturity date. You become a lender to the issuer, not an owner of it.

Governments and companies issue bonds to raise money for everything from budget deficits and new schools to factories and acquisitions. Bonds are the core of the broader fixed income category, which also includes certificates of deposit (CDs) and similar interest-paying investments.

How Do Bonds Work?

A standard bond has three terms:

• Face value (or par): the amount the issuer repays at maturity, commonly $1,000 per bond.
• Coupon rate: the annual interest rate, applied to face value. A $1,000 bond with a 5% coupon pays $50 a year, typically as two $25 payments.
• Maturity date: when the loan ends and your principal comes back. Most maturities range from a few weeks to 30 years.

Buy a bond at face value when it’s issued, collect the coupons, hold it to maturity, and your return is the coupon rate, as long as the issuer doesn’t default or call it early. Marketable bonds also trade on a secondary market after issue, so you can sell before maturity or buy one someone else already owns. Those trades happen at the market price, which is rarely exactly face value.

Bond Prices and Yields

A bond’s coupon is fixed when it’s issued, but its price changes daily, and the price you pay determines your actual return. That return is the bond’s yield.

Say you pay $950 for a $1,000 bond with a 5% coupon and 10 years left. Its current yield is $50 divided by $950, or about 5.3%. Its yield to maturity, which also counts the $50 you gain when the bond repays $1,000, is about 5.7%. Pay more than face value and the reverse happens: your yield falls below the coupon.

Prices and yields always move in opposite directions. When market interest rates rise, new bonds pay more, so older bonds with lower coupons fall in price until their yields match. Longer maturities fall further, because the lower coupon is locked in for more years. The fixed income entry shows how much prices move at different maturities when rates rise by one percentage point.

Types of Bonds

Who issues a bond determines most of its risk and how its interest is taxed.

Within Treasuries, the name depends on the term. Bills mature in 52 weeks or less, notes in 2 to 10 years, and Treasury bonds are issued with 20- or 30-year maturities.

Some bonds don’t fit the standard pattern. Zero-coupon bonds pay no interest along the way; you buy them at a discount and collect face value at maturity. Callable bonds let the issuer repay you early, usually when rates have fallen. Treasury Inflation-Protected Securities (TIPS) adjust their principal with the Consumer Price Index.

Bond Credit Ratings

Credit rating agencies grade issuers on their ability to pay. S&P Global and Fitch use a scale running from AAA down to D; Moody’s uses Aaa down to C. Bonds rated BBB- (Baa3 at Moody’s) or higher are investment grade. Anything below that is high yield, also called junk bonds.

Lower ratings mean higher yields, because investors want to be paid for the added chance of default. That extra yield over a comparable Treasury is called the credit spread. A rating is an opinion, not a guarantee, and agencies can downgrade an issuer during the life of the bond.

Bonds vs. Stocks

A stock makes you a part owner of a company. A bond makes you one of its lenders.

Stocks have historically earned higher long-term returns, with much deeper declines along the way. Bonds give up some of that growth for steadier value and predictable cash, which is why the stock-to-bond split is the central choice in asset allocation. Where you hold them matters too: taxable bond interest is ordinary income, so it often fits better in a tax-deferred account than in a taxable brokerage account.

In a ProjectionLab plan, you can give individual accounts their own bond allocation, such as keeping bonds in a traditional IRA while a brokerage account stays mostly in stocks.

Frequently Asked Questions

How do you buy bonds? New Treasury securities can be bought directly from the government at TreasuryDirect in $100 increments, or through a brokerage account at auction. Brokerages also sell Treasuries, municipal bonds, and corporate bonds on the secondary market. If you’d rather not pick individual bonds, a bond mutual fund or exchange-traded fund (ETF) holds hundreds of them in one position, though a fund never matures the way an individual bond does.

Is a savings bond the same as a bond? No. US savings bonds (Series EE and Series I) are Treasury products bought through TreasuryDirect, and they can’t be sold to anyone else. You can only cash them in with the Treasury. Marketable bonds trade freely between investors at prices that move with interest rates, while a savings bond’s value only grows.

What happens if a bond issuer defaults? You may get back only part of your money, or none of it, depending on the issuer’s assets and where your bond ranks among its debts. Secured bonds are backed by specific collateral, and all bondholders have a claim ahead of stockholders. Diversifying across many issuers, often through a fund, limits the damage from any single default.

What happens when a bond matures? The issuer pays you the face value along with the final interest payment, and the bond stops existing. You can reinvest that principal in a new bond, and a bond ladder staggers maturities so some money comes due every year.