What is a bond? – A bond represents a loan from an investor to a government or company. These entities issue debt to finance their operations and promise to repay investors the full amount, plus interest, in a specified time frame (typically ranging from one month to 30 years).  

More than one purpose – Different types of bonds have different characteristics, which helps them serve varying roles in a portfolio. The most common roles are to help dampen volatility from equities and potentially provide income, preserve capital, or hedge against rising inflation.

The word “bond” is a big umbrella – There are many types of bonds, from the governments of countries—in the US, other developed nations, and emerging markets—to government agencies and local townships. Corporations can issue bonds, too, the quality of which depends on their financial strength. Other bonds are backed by pools of underlying securities, such as mortgages or student loans.

What is a bond coupon? – A bond’s coupon is the amount of annual interest paid. In most cases, the coupon is a fixed percentage of the bond’s face value. For example, a $1,000 bond with a 4% coupon would pay $40 in interest per year.

Most bonds are rated – Third-party rating agencies each have their own systems, but they all assess how likely it is a bond will repay principal in full to the bondholder upon maturity. Generally, the lower the rating, the higher the risk and, therefore, the higher the interest paid.

What determines a bond’s price? – A bond purchased from an issuer costs its face value, called par value. But after the initial purchase, a bond’s price can fluctuate up or down on the secondary market, where bonds trade between brokers and dealers, based on market conditions.

What is bond yield? – A bond’s yield is the rate of return you could earn from it based on income payments and market price. Bond yields and prices move in opposite directions. For example, a $1,000 bond purchased at a 4% coupon would earn you about $40 annually. If interest rates rise to 4.5%, that $1,000 bond’s price would fall to about $889. At this lower price, the $40 coupon represents a yield of roughly 4.5%, helping keep old and new bonds competitive.

What is a bond’s maturity? – Maturity is the length of the bond’s term and can be measured in months, years, and even decades. If an investor holds a bond until maturity, its term ends, and that’s when the principal is repaid in full (unless the issuer defaults).

All investments have risks, even bonds – Some of the most common risks for bonds include credit risk (issuer fails to repay investors interest or principal at maturity) and interest-rate risk (bond prices rise or fall when interest rates change). Longer-term bonds are more sensitive to interest-rate changes than short-term bonds; this degree of sensitivity is called duration.

Ways to invest in bonds – Unlike stocks, most bonds aren’t publicly traded on an exchange. But investors can purchase them over the counter on a secondary market, through a broker, or, in the case of US Treasuries, directly from the government. There are also professionally managed mutual funds or exchange-traded funds that offer access to a wider variety of bonds and expert resources.