A bond is a debt security issued by a borrower to raise funds from investors. Its terms generally require interest payments and repayment of principal, although payment structures vary. Issuers include governments, public agencies, and companies. Unlike shares, which represent ownership, bonds normally make their holders creditors rather than owners. Bondholders’ contractual claims generally rank ahead of shareholders’ claims in corporate bankruptcy, but repayment is not guaranteed. Bonds form a major part of financial markets. (investor.gov)
Contractual structure
A bond’s face value, or par value, is the principal amount specified in its terms. Its maturity date identifies when principal becomes due. The coupon is the interest payment; for a conventional fixed-rate bond, the annual coupon rate is expressed as a percentage of face value. Thus, a hypothetical bond with a $1,000 face value and a 5 percent annual coupon pays $50 yearly, regardless of its subsequent trading price. Payments may be divided into installments. (investor.gov)
Corporate bonds are commonly governed by an indenture, a contract defining payment obligations and other conditions. Its covenants may restrict additional borrowing or require specified financial ratios. A trustee may monitor compliance and act for bondholders following a breach. These provisions help define credit risk, but do not eliminate it. (investor.gov)
Secured bonds have claims backed by specified collateral. Unsecured bonds rely on the issuer’s general ability to meet its obligations. Senior and subordinated debt occupy different positions in the repayment hierarchy: subordinated creditors rank behind specified senior creditors. Actual recoveries depend on available assets, contractual priority, and applicable insolvency rules. (investor.gov)
Principal varieties
Bonds can be classified by issuer, payment structure, credit quality, and embedded rights.
- Government bonds finance public borrowing. In the United States, Treasury bills, notes, and bonds are distinct categories of marketable government debt; “bond” is also used more broadly for debt securities. (treasurydirect.gov)
- Municipal bonds are issued by states, local governments, and related entities. General-obligation bonds typically rely on the issuer’s taxing resources, while revenue bonds depend on designated revenue sources, such as utility receipts. They often finance infrastructure. (investor.gov)
- Corporate bonds finance business activities, acquisitions, or refinancing. Investment-grade and high-yield classifications distinguish broad levels of assessed credit quality; high-yield debt carries greater estimated default risk. (investor.gov)
- Floating-rate bonds reset their coupons periodically against a benchmark interest rate. Zero-coupon bonds make no periodic coupon payments and are generally issued below their redemption value. (investor.gov)
Inflation-indexed bonds adjust specified payments using a price index. For example, U.S. Treasury Inflation-Protected Securities adjust principal using the Consumer Price Index; their fixed coupon rate applies to adjusted principal. At maturity, redemption is subject to an original-principal floor. Callable bonds permit issuer redemption before maturity under stated conditions, whereas convertible bonds permit conversion into shares according to contractual terms. (treasurydirect.gov)
Price and yield
A bond’s price is distinct from its face value. Trading above par means trading at a premium; below par means trading at a discount. For fixed cash flows, price and required yield move inversely: a higher discount rate reduces their present value, while a lower rate increases it. Changes in market rates or perceived creditworthiness can therefore change the price without changing the contractual coupon. (investor.gov)
Current yield equals annual coupon income divided by market price. Yield to maturity is the discount rate equating price with the present value of all scheduled coupons and principal repayment. It incorporates both coupon income and the difference between purchase price and redemption value. It is not a guaranteed realized return: default, early sale, and the rates available for reinvesting coupons can alter the outcome. (finra.org)
A yield curve plots yields against maturities for securities of comparable credit quality. Duration measures sensitivity to changes in yields rather than simply time remaining until maturity. Other things equal, longer maturities and lower coupons generally increase fixed-rate bonds’ interest-rate sensitivity. (finra.org)
Risks
Default risk concerns failure to meet contractual obligations. Credit ratings express assessments of relative creditworthiness and can change; they are not repayment guarantees. Even without default, deteriorating credit quality may reduce market value. (investor.gov)
Interest-rate risk concerns price changes as market yields move. Reinvestment risk arises when coupons or repaid principal must be invested at lower rates. Calls can intensify this problem because issuers may redeem high-coupon debt after rates fall. Inflation risk reduces the purchasing power of fixed nominal payments. Liquidity risk concerns difficulty selling promptly at an acceptable price. Holding a conventional bond to maturity avoids having to realize interim price fluctuations, but does not remove default or purchasing-power risk. (investor.gov)
Issuance and trading
New securities are sold in the primary market; subsequent transactions occur in the secondary market. Many bonds trade through dealers rather than on centralized exchanges. Transaction costs, dealer pricing, and infrequent trading can affect observed prices. For coupon bonds traded between payment dates, settlement commonly includes accrued interest owed to the seller. (sec.gov)
Investors may hold bonds directly or through mutual funds and exchange-traded funds. Fund shares represent interests in a portfolio, not an individual issuer’s promise to repay a particular face value on a specified date. Their value reflects portfolio prices and expenses; bond ETFs also trade throughout the exchange trading day. (finra.org)