What is a bond, and how does lending money to an issuer actually work?
A bond is an IOU: you lend money, the issuer pays interest and returns the principal on a set date. Here is how the cash flows work and what can go wrong.
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Bonds and interest rates: lending, not owning
A bond is a loan: you lend money to a government or company, and it promises to pay interest and repay the principal on a set date.
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A bond is a loan: you lend money to a government or company, and it promises to pay interest and repay the principal on a set date. These notes explain the parts of a bond, the seesaw between bond prices and interest rates, the difference between a coupon rate, current yield and yield to maturity, how U.S. Treasury bills, notes, bonds and TIPS differ, what credit ratings do and do not tell you, and the trade-offs between holding individual bonds and bond funds. Each claim links to the SEC, TreasuryDirect or another primary source. The notes below are listed in reading order: start at the top, or jump straight to the question you have. Every note ends with its numbered sources.
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Why do bond prices fall when interest rates rise?
A bond's coupon is fixed, but market rates are not. When new bonds pay more, older bonds must get cheaper to compete. Here is the arithmetic, with the SEC's own example.
Read the noteWhat is a bond's yield, and how is it different from the coupon?
The coupon is fixed when a bond is issued; the yield depends on what you pay for it. Here are the four yield numbers beginners meet, worked out in code.
Read the noteWhat are Treasury bills, notes and bonds, and how do they differ?
Bills, notes and bonds are all loans to the U.S. Treasury. The difference is mostly how long they last and how they pay you. Here is a side-by-side guide with worked numbers.
Read the noteWhat do bond credit ratings like AAA and BBB actually tell you?
AAA, BBB, BB: credit ratings sort bonds by how likely the issuer is to pay. Here is what the letters mean, where the investment-grade line sits and what ratings do not promise.
Read the noteBond funds vs individual bonds: which way of owning bonds fits you?
A single bond has a maturity date and a known payback; a bond fund promises neither, but spreads risk across many issuers. Here is how the two compare on cost, risk and control.
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