What is a bond?

A bond is a loan cut into pieces. A government or company wants to borrow a large sum, so it slices the debt into small units and sells them. Each unit carries the same promise: regular interest payments — the coupon — on fixed dates, and repayment of the face value when the bond matures. Buy one and you are not an owner, as you would be with a share; you are a lender, holding a promise with dates on it.

The promise, spelled out

Three numbers define the deal, and all are set at issue. The face value is what the issuer repays at maturity. The coupon is the interest paid along the way, fixed as an amount per bond. The maturity date is when the arrangement ends. Purely hypothetical arithmetic: a bond with a face value of 100 and a coupon of 3 pays 3 a year until maturity, then hands back the 100. Lending money for interest is one of the oldest entries on the short list of ways people make money; a bond is that loan, made portable.

Why prices move opposite to rates

The coupon never changes, but the world around it does. Suppose — all numbers hypothetical — that new bonds now pay 5 a year per 100. Nobody will pay 100 for an old bond paying 3 when the same 100 buys 5 elsewhere. The old bond must get cheaper until its buyer catches up. For the coupon alone to match, the price would have to fall to 60, because 3 paid on a price of 60 is 5 per cent. In practice the fall is smaller than that, since the buyer also collects the full 100 at maturity and that built-in gain counts towards the return. The direction is the lesson: when market rates rise, existing bond prices fall, and when rates fall, they rise. This hinge is much of how interest rates move markets.

Coupon is not yield

The coupon is fixed at issue and printed on the deal. The yield depends on the price actually paid. Pay 100 for the bond above and the coupons yield 3 per cent. Pay 60 and the same coupons yield 5 per cent. Same bond, same payments, different return — the difference lives in the price, not the paper. Two people holding identical bonds can be earning quite different yields, which surprises exactly one of them.

The promise is only a promise

Everything above assumes the issuer pays. That is an assumption, not a law of nature. An issuer in trouble can pay late, pay less, or not pay at all — default is the polite word. Lenders demand higher coupons from shakier issuers as compensation, which is why an unusually generous coupon usually signals an unusually shaky promise. The arithmetic of a bond is exact; the promise behind it is exactly as good as the entity making it.

What this does not claim to know

None of this says whether bonds suit anyone, in what amount, or now rather than later — that depends on prices, rates and circumstances no article knows. Every number here is invented for the arithmetic; real coupons, yields and prices live in the market on the day, not on this page.