In plain language — When you buy a bond, you become a creditor of the issuer, not an owner. The contract specifies interest, maturity and repayment, but the risk that the issuer will fail to perform remains.
A bond is a debt security. A government, public-sector entity, supranational organisation, bank or company raises capital and assumes the obligations described in the offering documents. These normally include repayment of the specified amount at maturity and, when applicable, interest payments.
“Fixed income” is a category name, not a promise that the price or outcome will be fixed. A bond can fluctuate, lose liquidity, be restructured or fail to be repaid in full.
Fundamental quantities
| Term | Meaning |
|---|---|
| Face value | reference amount often used to calculate the coupon and repayment |
| Coupon | periodic interest defined by the contract |
| Maturity | scheduled date for repayment or termination of the security |
| Price | what the market pays for the security today |
| Current yield | annual coupon / current price |
| Yield to maturity | rate incorporating price, cash flows and repayment, assuming the bond is held and contractual payments occur |
Coupon and yield are not synonyms. A bond with a face value of 1,000 and a 3% annual coupon pays 30 under the contract. If it is bought for 950, its current yield is approximately 3.16%; yield to maturity also considers repayment, time and all cash flows. No calculation removes default or reinvestment risk.
Why prices and interest rates move in opposite directions
For a fixed-rate security, when market-required yields rise, its old cash flows become relatively less attractive and its price tends to fall. When required yields fall, its price tends to rise.
Sensitivity depends on maturity, the distribution of cash flows, the coupon and optional features. In general, all else being equal, longer maturities and lower coupons imply greater interest-rate sensitivity. Bond duration summarises part of this exposure; convexity and DV01 describe its curvature and local money scale, respectively. None of the three exhausts credit, liquidity or nonlinear-payoff risk.
The yield curve compares yields at different maturities within a defined universe. It is not the price chart of one bond.
Main types
By issuer
- government bonds;
- corporate bonds;
- bank bonds;
- municipal or local-authority bonds;
- supranational issues.
By remuneration
- fixed rate;
- floating rate, linked to an index plus a spread;
- zero coupon, with no periodic coupon;
- inflation-linked;
- structured, with derivative components and more complex payoffs.
By priority
Senior, subordinated, secured and unsecured securities have different priority and protection in insolvency. The word “bond” alone does not determine where the claim sits in the capital structure.
Early-redemption, conversion, extension or payment-suspension clauses can materially change the profile.
Primary and secondary markets
The security is issued in the primary market. In the secondary market, it passes between investors at a price reflecting rates, credit, liquidity and the contract terms.
Holding to maturity reduces the relevance of interim price fluctuations only if:
- the issuer pays in full and on schedule;
- the security is not redeemed, converted or restructured differently;
- the investor does not need to sell beforehand;
- the cash flows and currency retain the value expected for the investor's objective.
Observable prices may be less transparent and liquidity more fragmented than in heavily traded stocks.
Main risks
- credit/default — missed payment or restructuring;
- interest rate — price changes as market yields change;
- credit spread — additional required yield over a reference;
- inflation — erosion of the real value of nominal cash flows;
- liquidity — difficulty selling or an unfavourable sale price;
- call — early redemption when reinvestment is less favourable;
- reinvestment — coupons or principal reinvested at different rates;
- currency — cash flows in a currency different from the investor's reference currency;
- subordination and covenants — lower priority or a conditional payoff.
A higher promised yield is not a gift: it may reflect greater risk, lower liquidity or more burdensome terms.
Individual bond, fund and bond ETF
An individual bond has a specific issuer, cash flows and maturity. A fund or bond ETF holds a portfolio that buys and sells securities: its shares normally do not “mature” with the individual bonds, and their value continues to vary.
Fund diversification may reduce the impact of one default, but does not remove interest-rate, credit, currency, liquidity or cost risk. The portfolio's duration must be examined, not merely the word “bond” in its name.
Minimum checklist
- issuer and jurisdiction;
- ISIN, currency, face value and price;
- maturity, coupon and cash-flow schedule;
- seniority, security and covenants;
- calculated yield and the assumptions used;
- duration and interest-rate sensitivity;
- credit quality and concentration;
- secondary market, spread and minimum size;
- possibility of call, conversion or restructuring;
- difference between an individual security and a fund.
Common mistake — Reading “6% coupon” as “certain 6% return”. Purchase price, maturity, credit, currency, terms and costs determine the actual result.
Sources
- U.S. Securities and Exchange Commission, Investor.gov, Bonds — FAQs.
- U.S. Securities and Exchange Commission, Investor.gov, Fixed Income Investments — When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall.
- U.S. Securities and Exchange Commission, Investor.gov, What Are Corporate Bonds?.
- Banca d'Italia, L'economia per tutti, Obbligazioni.
- Banca d'Italia, Glossario delle tipologie di strumenti finanziari.