Bond
By WikiWealth Editorial Team|Last updated:
Key Takeaways
- A bond is a loan from an investor to a borrower, typically a corporation or government entity
- Bonds pay periodic interest (coupon payments) and return the principal at maturity
- Bond prices move inversely to interest rates — when rates rise, bond prices fall
- Bonds are generally considered lower-risk than stocks but offer lower long-term returns
Definition
A bond is a fixed-income debt security in which an investor loans money to a borrower — typically a corporation or government — for a defined period at a fixed or variable interest rate. The bond issuer agrees to make regular interest payments (known as coupon payments) and to repay the face value (par value) of the bond when it matures. Bonds are a primary tool for governments and companies to finance operations, projects, and debt refinancing.
How It Works
When you purchase a bond, you are essentially lending money to the issuer. In return, the issuer pays you interest at a predetermined rate on a regular schedule (usually semiannually for U.S. bonds). At maturity, you receive the bond's par value back. Bond prices fluctuate in the secondary market based on changes in prevailing interest rates, the issuer's credit rating, and time remaining to maturity. The key relationship is that bond prices and yields move inversely: when interest rates rise, existing bond prices fall (because newer bonds offer higher yields), and vice versa. Major bond categories include Treasury bonds, municipal bonds, corporate bonds, and high-yield (junk) bonds.
Example
Suppose you buy a 10-year corporate bond with a $1,000 par value and a 5% annual coupon rate. You will receive $50 per year in interest payments ($25 every six months). After 10 years, you receive your $1,000 principal back. Over the life of the bond, you earn $500 in total interest plus the return of your $1,000 investment. However, if market interest rates rise to 7% after you purchase the bond, its market price will fall below $1,000 because new bonds offer higher yields — though you still receive the full $1,000 at maturity if you hold to term.
Why It Matters
Bonds play a critical role in diversification because they often behave differently from stocks. They provide predictable income streams, help preserve capital, and reduce overall portfolio volatility. The bond market is actually larger than the stock market globally, and bond yields serve as key economic indicators — the yield curve is one of the most closely watched recession predictors.
Advantages
- Provide predictable, regular income through coupon payments
- Generally less volatile than stocks, offering portfolio stability
- Return of principal at maturity provides a known investment outcome if held to term
- Government bonds (especially Treasuries) are considered among the safest investments available
Limitations
- Lower long-term returns compared to stocks — historically around 5% to 6% annually vs. 10% for stocks
- Interest rate risk: rising rates cause bond prices to decline
- Credit risk: corporate and municipal bond issuers can default on payments
- Inflation risk: fixed coupon payments lose purchasing power if inflation rises
Frequently Asked Questions
Related Terms
Browse more definitions in the financial terms glossary.