What is a bond, in plain words?Easy

A loan cut into tradeable pieces. The lender can sell their piece to somebody else, and that one fact produces almost everything else about bonds.

4 min read · 678 words

The short answer: a bond is a loan cut into pieces small enough to trade. A government or a company borrows, promises to pay interest on a schedule and the amount back on a stated date, and issues certificates saying so. If you own one, you are a lender — and unlike a bank you can sell your piece to somebody else tomorrow.

The four facts that define one

• The face value — what gets repaid at the end, per unit. Bonds are quoted per 100 of face value, which is why prices look like 98.40 rather than like money.
• The coupon — the interest, usually a fixed percentage of face value, usually paid once or twice a year.
• The maturity — the date the face value comes back.
• Who is promising — a government, a company, a bank. This is the fact everything else hangs off.

That is all a plain government bond is. A corporate bond is the same four facts with a company's name on it, and the difference in price is what the market charges for the difference in promise.

Why the price moves when the coupon does not

Here is the thing most people find genuinely surprising: the coupon is fixed for the life of the bond, so if the going rate on new bonds changes, the only part of an old bond that can move is its price. New bonds pay more, yours pays the same, so yours is worth less. Rates fall, yours is worth more. Why a bond falls when rates rise works it through, and why a bond trades above 100 is the same mechanism running the other way.

How far it moves for a given change in rates has a name and a number — duration — and it is the one bond measure worth learning early.

Yield is four numbers wearing one word

"The yield" can mean the coupon over the price, the return if you hold to maturity, the return to the first date the borrower can repay early, or the spread over a government bond. They are different numbers and a quote is nearly useless until you know which one you are being shown. What yield actually means separates them.

The two risks, and which one decides

• The rate moves. Everything above. It affects the price today and not what you get at maturity if you hold it.
• The borrower does not pay. Then the schedule stops mattering and where you stand in the queue starts to. On a government bond in its own currency this is a small worry; on a high-yield bond it is the whole question.

Which of the two decides the outcome depends entirely on who is borrowing, and every product page here states which failure mode dominates for that instrument rather than leaving you to guess. A credit rating is one opinion about the second risk and says nothing at all about the first.

Where you sit if it goes wrong

A bondholder is a creditor, and creditors are paid before shareholders. That ordering is a contract rather than a courtesy, it was fixed the day the bond was issued, and it decides more about the outcome than how bad the failure was. Who gets paid sets out the queue, and what happens in a restructuring is what it looks like in practice.

Why so many kinds exist

Every variation answers a question somebody had. A floating rate note moves its coupon with rates so the price does not have to. A callable bond lets the borrower repay early, which is an option they hold and you sold. An inflation-linked bond keeps its purchasing power rather than its number. A zero-coupon bond pays no interest at all and is sold below face value instead.

The one sentence to take away

A bond is a loan you can sell, so its price answers a different question from its coupon — the coupon is what the borrower promised, and the price is what somebody else will pay you today for that promise.