A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.


Loading the player...


Bonds are commonly referred to as fixed-income securities and are one of the three main generic asset classes, along with stocks (equities) and cash equivalents. Many corporate and government bonds are publicly traded on exchanges, while others are traded only over-the-counter (OTC).

How Bonds Work

When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing other debts, they may issue bonds directly to investors instead of obtaining loans from a bank. The indebted entity (issuer) issues a bond that contractually states the interest rate (coupon) that will be paid and the time at which the loaned funds (bond principal) must be returned (maturity date).

The issuance price of a bond is typically set at par, usually $100 or $1,000 face value per individual bond. The actual market price of a bond depends on a number of factors including the credit quality of the issuer, the length of time until expiration, and the coupon rate compared to the general interest rate environment at the time.


Because fixed-rate coupon bonds will pay the same percentage of its face value over time, the market price of the bond will fluctuate as that coupon becomes desirable or undesirable given prevailing interest rates at a given moment in time. For example if a bond is issued when prevailing interest rates are 5% at $1,000 par value with a 5% annual coupon, it will generate $50 of cash flows per year to the bondholder. The bondholder would be indifferent to purchasing the bond or saving the same money at the prevailing interest rate.

If interest rates drop to 4%, the bond will continue paying out at 5%, making it a more attractive option. Investors will purchase these bonds, bidding the price up to a premium until the effective rate on the bond equals 4%. On the other hand, if interest rates rise to 6%, the 5% coupon is no longer attractive and the bond price will decrease, selling at a discount until it's effective rate is 6%.

Because of this mechanism, bond prices move inversely with interest rates.

Characteristics of Bonds

  • Most bonds share some common basic characteristics including:
  • Face value is the money amount the bond will be worth at its maturity, and is also the reference amount the bond issuer uses when calculating interest payments.
  • Coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.
  • Coupon dates are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi-annual coupon paymets.
  • Maturity date is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond.
  • Issue price is the price at which the bond issuer originally sells the bonds.

Two features of a bond – credit quality and duration – are the principal determinants of a bond's interest rate. If the issuer has a poor credit rating, the risk of default is greater and these bonds will tend to trade a discount. Credit ratings are calculated and issued by credit rating agencies. Bond maturities can range from a day or less to more than 30 years. The longer the bond maturity, or duration, the greater the chances of adverse effects. Longer-dated bonds also tend to have lower liquidity. Because of these attributes, bonds with a longer time to maturity typically command a higher interest rate.

When considering the riskiness of bond portfolios, investors typically consider the duration (price sensitivity to changes in interest rates) and convexity (curvature of duration).

Bond Issuers

There are three main categories of bonds.

  • Corporate bonds are issued by companies.
  • Municipal bonds are issued by states and municipalities. Municipal bonds can offer tax-free coupon income for residents of those municipalities.
  • U.S. Treasury bonds (more than 10 years to maturity), notes (1-10 years maturity) and bills (less than one year to maturity) are collectively referred to as simply "Treasuries."

Varieties of Bonds

  • Zero-coupon bonds do not pay out regular coupon payments, and instead are issued at a discount and their market price eventually converges to face value upon maturity. The discount a zero-coupon bond sells for will be equivalent to the yield of a similar coupon bond.
  • Convertible bonds are debt instruments with an embedded call option that allows bondholders to convert their debt into stock (equity) at some point if the share price rises to a sufficiently high level to make such a conversion attractive.
  • Some corporate bonds are callable, meaning that the company can call back the bonds from debtholders if interest rates drop sufficiently. These bonds typically trade at a premium to non-callable debt due to the risk of being called away and also due to their relative scarcity in today's bond market. Other bonds are putable, meaning that creditors can put the bond back to the issuer if interest rates rise sufficiently.

The majority of corporate bonds in today's market are so-called bullet bonds, with no embedded options whose entire face value is paid at once on the maturity date.

  1. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  2. Yield To Maturity (YTM)

    The total return anticipated on a bond if the bond is held until ...
  3. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  4. Grexit

    Grexit, an abbreviation for "Greek exit," refers to Greece's ...
  5. Indenture

    A legal and binding contract between a bond issuer and the bondholders. ...
  6. Auction Rate Bond - ARB

    A debt security with an adjustable interest rate and fixed term ...
Related Articles
  1. Bonds & Fixed Income

    Junk Bonds: Everything You Need To Know

    Don't be fooled by the name - junk bonds may be for you if you know how to analyze them.
  2. Home & Auto

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  3. Retirement

    Should Balanced Funds Be Part Of Your Portfolio?

    Find out why you should include balanced funds in your portfolio, including the importance of customizability, diversification and professional management.
  4. Investing Basics

    6 Investing Mistakes That the Ultra Wealthy Don't Make

    Understand what ultra-high-net-worth individuals are and how they invest. Learn about the six key investment mistakes that the ultra wealthy avoid.
  5. Mutual Funds & ETFs

    Finding Lower Risk, Higher Return Mutual Funds

    Discover detailed analysis of lower-risk, higher-return balanced mutual funds, and learn about the characteristics of this type of mutual fund.
  6. Economics

    How Does the Puerto Rican Debt Crisis Affect the US?

    Learn about the specifics of the Puerto Rican debt crisis and why economists disagree on how significantly it could affect the United States.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Bond

    Find out about the Vanguard Intermediate-Term Bond ETF, and delve into detailed analysis of this fund that invests in investment-grade intermediate-term bonds.
  8. Economics

    How Do Asset Bubbles Cause Recessions?

    Understand how asset bubbles often lead to deep, protracted recessions. Read about historical examples of recessions preceded by asset bubbles.
  9. Bonds & Fixed Income

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  10. Investing Basics

    Predicting Investment Losses

    How much you stand to lose on an investment and how long those losses will last can be gauged ahead of time.
  1. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  2. How does an IRA grow over time?

    Individual retirement account, or IRA, growth depends on many factors, including what types of investments are included in ... Read Full Answer >>
  3. What is the effective interest method of amortization?

    The effective interest method is an accounting practice used for discounting a bond. This method is used for bonds sold at ... Read Full Answer >>
  4. What is affected by the interest rate risk?

    Interest rate risk is the risk that arises when the absolute level of interest rates fluctuate. Interest rate risk directly ... Read Full Answer >>
  5. What is a barbell fixed-income strategy?

    A barbell fixed-income strategy is an investment strategy in which a portfolio is comprised of long- and short-term bonds. ... Read Full Answer >>
  6. Under what circumstances might an issuer redeem a callable bond?

    The primary circumstance under which a bond issuer redeems a callable bond is a drop in interest rates. When rates fall, ... Read Full Answer >>
  7. Are stock investors technically creditors?

    Investors who buy stock in a publicly traded company actually own small pieces of the company and are not creditors. Creditors ... Read Full Answer >>
  8. What are the full rights of creditors in cases of bankruptcy?

    Creditors have a right to company assets before company owners do during bankruptcy proceedings. Company assets are liquidated ... Read Full Answer >>
  9. What happened to Nathan Rothschild's estate after his death?

    The Rothschild family has been involved in global finance for centuries. Nathan Rothschild was among those responsible for ... Read Full Answer >>
  10. What are some examples of the most common types of investments on an IRA?

    The most commonly held investments in individual retirement accounts include savings accounts, U.S. savings bonds, certificates ... Read Full Answer >>
  11. What does it mean when a bond has a put option?

    A put option on a bond is a provision that allows the holder of the bond the right to force the issuer to pay back the principal ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  2. Bullish Engulfing Pattern

    A chart pattern that forms when a small black candlestick is followed by a large white candlestick that completely eclipses ...
  3. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  4. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  5. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
Trading Center