Bond
A bond is a debt security in which an issuer borrows from investors and promises interest, principal repayment, or both under stated terms.
A bond is a debt security. When an investor buys a bond, the investor lends money to a bond issuer such as a government, municipality, corporation, or public authority. The issuer promises to make interest payments, repay principal, or both under the bond terms.
A bond is not the same as a stock. A stock represents ownership. A bond represents a creditor claim that depends on the issuer’s ability and legal obligation to pay.
A plain-vanilla bond is a timeline of cash flows: purchase now, coupons during the life of the bond, and principal back at maturity.
Key Takeaways
- Bonds are debt instruments, not ownership interests.
- The main terms are issuer, bond face value, coupon rate, maturity date, price, and yield.
- Bond prices and yields usually move in opposite directions.
- Scheduled payments are not guarantees; credit risk, interest-rate risk, liquidity risk, call risk, and inflation risk still matter.
Core Parts Of A Bond
| Part | Plain-English meaning | Why it matters |
|---|---|---|
| Issuer | Borrower that sells the bond | Determines credit exposure and disclosure record. |
| Face value | Contractual principal reference amount | Used for coupon calculations and maturity repayment. |
| Coupon rate | Stated annual interest rate on face value | Determines scheduled interest payments. |
| Maturity date | Date principal is due, unless repaid earlier | Drives duration, reinvestment risk, and repayment timing. |
| Market price | What investors pay today | Can be above, below, or near face value. |
| Yield | Return measure based on price, coupon, and timing | Lets investors compare bonds with different prices and coupons. |
Basic Bond Pricing
A simple fixed-rate bond is valued as the present value of remaining coupon payments plus the face value due at maturity:
Where:
- \(P\) = bond price
- \(C\) = coupon payment
- \(r\) = market yield or discount rate
- \(F\) = face value
- \(n\) = number of remaining periods
The formula is a teaching simplification. Real bonds may include call features, sinking funds, taxes, accrued interest, odd coupon dates, liquidity discounts, and default risk.
Price, Yield, Premium, And Discount
If market yields rise, an older bond with a lower coupon becomes less attractive, so its price generally falls. If market yields fall, an older bond with a higher coupon becomes more attractive, so its price generally rises.
| Price position | What it means | Common reason |
|---|---|---|
| At par | Price is near face value | Coupon is close to current market yield. |
| Premium | Price is above face value | Coupon is higher than comparable market yields, or terms are attractive. |
| Discount | Price is below face value | Coupon is lower than market yields, credit risk has risen, or liquidity is weak. |
Practical Example
Suppose a bond has $1,000 face value, a 5% annual coupon, and annual payments. The scheduled coupon is $50 per year. If comparable market yields fall to 4%, investors may pay more than $1,000 for that 5% coupon. If comparable market yields rise to 6%, the bond may trade below $1,000.
Common Bond Types
- Corporate Bond: Company debt.
- Municipal Bond: State, local, or public-authority debt.
- Treasury Bond: Long-term U.S. Treasury marketable security.
- Zero-Coupon Bond: Bond sold at a discount and paid at maturity without regular coupons.
- Callable Bond: Bond the issuer may redeem before maturity under stated terms.
Common Mistakes
- Confusing coupon rate with total return.
- Assuming a bond is safe because it has a maturity date.
- Ignoring duration and interest-rate sensitivity.
- Comparing yields without checking credit quality, call features, tax treatment, and liquidity.
- Treating an individual bond and a bond fund as if they have the same maturity behavior.
What To Verify
Check the issuer, CUSIP, face value, coupon, maturity, price, yield, accrued interest, call schedule, seniority, collateral, credit rating context, tax status, settlement date, custody record, and the final prospectus, official statement, or indenture.
Public Source Checks
Investor.gov’s bond overview is useful for beginner bond mechanics and risks. FINRA’s bond due-diligence guidance highlights price, yield, liquidity, and trade checks. TreasuryDirect marketable securities explains U.S. Treasury bills, notes, bonds, TIPS, and FRNs.
Related Terms
- Bond Face Value: Principal reference amount for coupon and maturity repayment.
- Bond Yield: Return measure affected by price, coupon, maturity, and risk.
- Yield to Maturity: Estimated return if a bond is held to maturity under stated assumptions.
- Credit Spread: Extra yield investors demand for credit risk.
- Bondholder: Investor that owns the debt claim.