Bonds 101: the IOU you can buy
A bond is a loan you make to a government or company. They pay you interest, then give you your money back. Here is how that actually works.
Written for plain-English understanding by Joseph Citizen. Why I built this →
A bond is a loan. You give a government or a company some money. They promise to pay you a set amount of interest at regular intervals, then return your original amount on a specific date.
If you buy a 10-year U.S. Treasury bond for $1,000 paying 4%, the U.S. government will send you $40 each year for ten years and return your $1,000 at the end. That is the whole product.
The three numbers that matter
- Face value (or par) — the amount you get back at the end. Usually $1,000.
- Coupon rate — the interest rate. The 4% in our example.
- Maturity — when you get your money back. Two years, ten years, thirty years.
Why bond prices move
If you buy a bond paying 4% and then new bonds start paying 6%, your old bond becomes less attractive. Its price on the resale market drops. The reverse is also true — when interest rates fall, existing bonds with higher rates get more valuable.
This is why people say 'when rates go up, bond prices go down' — they are inversely related. If you hold the bond to maturity and the issuer does not default, you still get exactly what you were promised.
Types you will hear about
- Treasuries — issued by the U.S. government. Considered the safest bonds in the world.
- Municipal bonds (munis) — issued by states and cities. Often tax-advantaged.
- Corporate bonds — issued by companies. Higher rates, but riskier.
- High-yield (junk) bonds — issued by companies with weaker finances. Pay more, but more likely to default.
Quick check on this lesson
Answer each question and we'll show you why the right answer is right — and why the others aren't.
- 1.
What is a bond, in plain English?
- 2.
If interest rates RISE, what happens to the price of existing bonds with lower rates?
- 3.
Which type of bond is generally considered SAFEST?
- 4.
Why do bond prices generally rise when interest rates fall?
- 5.
What does 'yield' mean for a bond?
- 6.
When are bonds typically MORE useful in a portfolio?
0 of 6 answered
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Important
This lesson is general financial education only. It is not personal investment, tax, accounting, or legal advice. Examples are illustrative. Past performance does not guarantee future results.