When the 30-year Treasury yield makes headlines, it's easy to feel that bonds are a language you were never taught. They aren't hard. A bond is a loan, and every number attached to it has a plain meaning. This is Part 1 of our Bonds, Explained series, and it starts with the pieces everything else builds on.
What a bond is
Investor.gov calls a bond "a debt security, like an IOU." When you buy one, you lend money to an issuer, which can be a government, a municipality, or a corporation. The issuer promises to pay a specified rate of interest during the life of the bond and to repay the principal, also called the face value or par value, when the bond comes due. Interest is typically paid on a regular schedule, such as every six months.
| Term | What it means | In our example |
|---|---|---|
| Face value (par) | The amount repaid at maturity. FINRA notes bonds are typically $1,000 each at par. | $1,000 |
| Coupon | The interest payment, set as a percentage of face value when the bond is issued. It's usually paid twice a year and, on a fixed-rate bond, doesn't change. | 4.5%, or $45 a year |
| Maturity | The date the principal is repaid. | 10 years from issue |
| Issuer | Who owes the money. U.S. Treasuries carry the full faith and credit of the U.S. government, according to Investor.gov. | Hypothetical |
Why bond prices move
Here's the part that confuses people. A bond's coupon is fixed, but its market price isn't. If you sell before maturity, a buyer decides what the bond is worth, and that depends on what new bonds are paying. The SEC states the rule plainly in an investor bulletin: "When market interest rates rise, prices of fixed-rate bonds fall." Investor.gov explains why: to sell an older bond with a lower interest rate, you might have to sell it at a discount, because new bonds are more appealing.
Put numbers on it. Suppose your hypothetical 4.5% bond has 10 years left. If market rates for similar bonds are also 4.5%, it's worth about its $1,000 face value. If rates rise, a buyer won't pay $1,000 for a bond paying less than a new one would.
| Market rate for similar bonds | Approximate price | Change from $1,000 |
|---|---|---|
| 3.5% | $1,083 | +8.3% |
| 4.5% | $1,000 | 0.0% |
| 5.5% | $925 | −7.5% |
| 6.5% | $856 | −14.4% |
Our calculation, assuming annual coupon payments for simplicity. The pattern is the point: prices and rates move in opposite directions. Rate changes hit longer-maturity bonds and lower-coupon bonds harder, which is the subject of Part 4.
If you hold to maturity
The SEC adds an important comfort: if you intend to hold a bond to maturity, day-to-day price swings may not matter as much to you. You'll still receive the coupon payments and your principal back, assuming the issuer doesn't default. The price only becomes a realized gain or loss if you sell early. That's why a rate spike can hurt a bond fund's reported value immediately while an investor who holds a single bond to maturity can simply wait it out.
The three main risks
- Interest rate risk. The price falls when rates rise. The SEC says this is common to all bonds, even U.S. Treasury bonds, and that the government does not guarantee a bond's market price.
- Credit risk. The issuer might not pay. Treasuries are considered to have minimal credit risk. Corporate bonds carry more, which is a major reason they usually pay higher yields than Treasuries.
- Inflation risk. FINRA notes that all bonds except those that adjust for inflation, such as TIPS, expose you to inflation risk, since fixed payments buy less if prices rise. Part 5 covers the inflation-protected options.
Common questions
What is a bond in simple terms?
A bond is a loan you make to a government or company. The issuer promises to pay interest on a regular schedule and to return your principal, the face value, on a set maturity date.
Why do bond prices fall when interest rates rise?
Because new bonds start paying the higher rate, making older, lower-rate bonds less attractive. To sell an older bond, you may have to accept a lower price. The SEC describes this as interest rate risk.
Can you lose money on a bond?
Yes. If you sell before maturity after rates have risen, you may receive less than you paid. If the issuer defaults, you may lose some or all of your investment. If you hold a Treasury to maturity, you receive the face value back.
- Investor.gov, Bonds
- SEC, Interest Rate Risk: When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall
- FINRA, Bonds
- FINRA, TIPS and STRIPS
- Treasury Bills, Notes, Bonds, and TIPS: What Each One Is
- Bond Yield vs. Coupon: Why the Rate on the Bond Isn't the Rate You Earn
- Bond Duration Explained: How Much a Rate Move Can Hurt
- I Bonds vs. TIPS: Two Ways Treasury Protects Against Inflation
- Bond Ladders and the Yield Curve: Reading What Treasury Rates Are Saying