What is a bond?
A bond is a loan you make to a government, agency or company. The issuer promises to pay regular interest—the coupon—and repay the face value at maturity. Bondholders are lenders, not owners, which is the core difference from stocks (Fabozzi, 2021).
Why do bond prices fall when interest rates rise?
A bond's price is the present value of its future coupons and principal, discounted at current market rates. If you hold a bond paying 3% and new bonds pay 5%, yours has to sell at a discount to compete. That's why bond prices and interest rates move in opposite directions. The annual return you'd earn by buying at today's price and holding to maturity is the yield to maturity (YTM).
| Term | What it means | Why it matters |
|---|---|---|
| Yield to maturity (YTM) | Return if bought now and held to maturity | What people usually mean by a bond's "yield" |
| Duration | Weighted average time to receive cash flows (Macaulay, 1938) | Approximate % price change for a 1-point rate move |
| Credit rating | Assessment of the issuer's ability to repay | Lower ratings pay higher yields (risk premium) |
Types of bonds and their risks
Government bonds such as U.S. Treasuries carry the least credit risk, while corporate bonds pay more depending on their credit rating. Longer-duration bonds swing more when rates change (Bodie et al., 2021), and fixed coupons lose real value when prices rise, exposing bonds to inflation risk. For how reinvested interest grows, see compound interest.
FAQ
- Is a bond's principal guaranteed?
- If you hold to maturity and the issuer doesn't default, you get your principal and interest back. Selling early can mean a loss if rates have risen.
- Why do bonds get popular when rates are expected to fall?
- Falling rates push up the prices of existing bonds, so investors can earn price gains on top of interest.
Sources reviewed: 2026-10-25
References
- Fabozzi, F. J. (2021). Bond markets, analysis, and strategies (10th ed.). Pearson.
- Bodie, Z., Kane, A., & Marcus, A. J. (2021). Investments (12th ed.). McGraw-Hill Education.
- Macaulay, F. R. (1938). Some theoretical problems suggested by the movements of interest rates, bond yields and stock prices in the United States since 1856. National Bureau of Economic Research.