Bond
A bond is a loan you make to a government or company that pays interest over time and returns the original amount at the end.
A bond is a loan you make to a government or company that pays interest over time and returns the original amount at the end.
Why it matters
When you buy a bond, you are lending money. In return, the borrower agrees to pay you interest on a set schedule and to repay the original amount, called the principal, on a future date. That predictable structure is what makes bonds different from stocks.
Bonds are often used to add steadier income and to balance the swings of stocks. In many portfolios they play a calming role, since high-quality bonds tend to move less dramatically than shares.
Bonds are not risk-free. The borrower could fail to pay, which is credit risk, and the market value of a bond falls when interest rates rise, which is interest-rate risk. Understanding those two risks explains most of how bonds behave.
Simple example
Suppose you buy a bond for $1,000 that pays 4 percent a year for ten years. Each year you receive about $40 in interest, and at the end you get your $1,000 back, as long as the borrower stays able to pay. If interest rates later rise and new bonds pay 6 percent, your 4 percent bond becomes less attractive, so its market price would fall if you tried to sell it early. Hold it to the end, though, and you still collect the agreed interest and principal.
Common mistakes
- Assuming all bonds are safe. A stable government bond and a shaky company bond carry very different risks.
- Confusing the yield with the price. When one rises, the other generally falls.
- Forgetting that selling a bond early can mean getting less than you paid if rates have risen.
- Ignoring inflation, which can quietly erode the real value of fixed interest payments.
- Treating bonds as having no role, when they often steady a portfolio.
How to think about it
Practical pointers for learning, not advice to buy or sell anything.
- 1Separate the two main risks: will the borrower pay, and what are interest rates doing.
- 2Match the bond's time frame to when you will need the money.
- 3Use high-quality bonds for steadiness, not for the kind of growth stocks can offer.
Frequently asked questions
What is a bond?
A bond is a loan from an investor to a government or company. The borrower agrees to pay interest on a set schedule and to repay the original amount on a future date, which makes a bond more predictable than a stock.
How do bonds make money?
Mainly through interest payments, often called the coupon, paid on a regular schedule. You can also gain or lose if you sell a bond before it matures and its market price has changed.
Why do bond prices fall when interest rates rise?
Because new bonds start paying the higher rate, an older bond paying less becomes less attractive. To sell it, you would have to lower the price so its return matches what new bonds offer.
Are bonds safer than stocks?
High-quality bonds usually swing less than stocks and have a clearer repayment promise, so they are often considered steadier. But bonds still carry risks, including the borrower failing to pay and losing value when rates rise.
What is the difference between a bond and a stock?
A bond is a loan that pays interest and returns your principal, making you a lender. A stock is part-ownership of a company, making you an owner with a share of its success or failure. They behave differently.
What is credit risk?
Credit risk is the chance that the borrower cannot make its interest payments or repay the principal. Bonds from very stable governments carry low credit risk, while bonds from weaker borrowers pay more to compensate for higher risk.
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Educational content only. This is a plain-English explanation for learning. It is not investment advice or a recommendation to buy or sell anything. Examples are simplified and do not predict real results. Always do your own research and consider speaking with a licensed financial professional.