A bond is a way for governments and companies to borrow money from investors. When you buy a bond, you are lending money to the issuer for a set amount of time. In return, the issuer promises to pay interest and repay the original amount at maturity.
Bonds matter because they help pay for roads, schools, factories, and business expansion while giving investors a source of income.
Key Facts
- Bond price and market interest rates usually move in opposite directions.
- Annual coupon payment = face value × coupon rate.
- Current yield = annual coupon payment ÷ current bond price.
- A bond with a 50 per year.
- Maturity is the date when the issuer repays the bond's face value.
- Higher default risk usually means investors demand a higher interest rate.
Vocabulary
- Bond
- A bond is a loan an investor makes to a government or company in exchange for interest payments and repayment later.
- Issuer
- The issuer is the government, city, or company that borrows money by selling a bond.
- Coupon rate
- The coupon rate is the stated annual interest rate paid on the bond's face value.
- Face value
- Face value is the amount the issuer promises to repay when the bond matures.
- Yield
- Yield is the return an investor earns on a bond based on its payments and price.
Common Mistakes to Avoid
- Thinking a bond is the same as a stock is wrong because a bond is debt while a stock is ownership in a company.
- Ignoring interest rate changes is wrong because rising market rates can lower the price of existing bonds.
- Assuming all bonds are risk-free is wrong because companies and governments can have different chances of missing payments.
- Confusing coupon rate with yield is wrong because the coupon rate is based on face value, while yield depends on the price you actually pay.
Practice Questions
- 1 A company sells a bond with a $1,000 face value and a 6% coupon rate. How much interest does the bond pay each year?
- 2 A bond pays 800. What is its current yield?
- 3 A student owns a bond paying 4% interest. New bonds of similar risk start paying 6%. Explain what will likely happen to the price of the student's bond and why.