A bond is a loan that an investor makes to a government or a company, packaged as a tradable security. The issuer promises to pay interest — the coupon — at regular intervals and to repay the face value at maturity. Bonds let governments fund budgets and infrastructure and let companies borrow from many investors at once. For investors, they provide predictable income and diversification alongside shares.
What you will learn
- Explain the key features of a bond
- Compare government and corporate bonds
- Understand credit ratings and credit spreads
- Recognise the main risks of investing in bonds
Key features
| Feature | Meaning | Example |
|---|---|---|
| Face (par) value | Amount repaid at maturity; coupons are calculated on it | 1,000 |
| Coupon rate | Annual interest as a percentage of face value | 8% → 80 a year |
| Coupon frequency | How often coupons are paid | Annually or semi-annually |
| Maturity | Date the face value is repaid | 5, 10 or 20 years |
| Issue price | Price at which the bond is first sold | At, above or below par |
| Yield | The return implied by the current market price | See bond pricing and yield |
The coupon is fixed for most bonds, but floating-rate bonds reset their coupons periodically by reference to a benchmark rate, and zero-coupon bonds pay no coupon, being issued at a deep discount and repaid at par.
Worked example: cash flows of a bond
A company issues a 5-year bond with face value 1,000 and an 8% annual coupon (illustrative figures).
- Coupons: 8% × 1,000 = 80 at the end of each of years 1 to 5.
- Repayment: 1,000 at the end of year 5.
- Total cash received by a buyer who holds to maturity: 5 × 80 + 1,000 = 1,400.
If the investor paid 1,000, the return is 8% a year. If market rates change and the investor pays more or less than 1,000, the return differs from the coupon rate. The bond yield calculator shows the effect.
Government bonds
Governments issue treasury bonds (longer term) and treasury bills (up to one year). Bonds issued by a government in its own currency are generally considered the lowest-credit-risk assets in that currency, because the government can tax and, through its central bank, influence the money supply. Their yields form the benchmark yield curve against which other borrowing is priced — see the yield curve.
In Bangladesh, the government issues treasury bonds of several maturities through auctions conducted by Bangladesh Bank, and has also issued Islamic sukuk. Governments also borrow in foreign currencies, which adds exchange-rate risk for the issuer.
Corporate bonds
Companies issue bonds to finance investment as an alternative to bank loans. Corporate bonds pay a higher yield than government bonds to compensate for credit risk — the chance the company cannot pay. Common features include:
- Secured or unsecured — secured bonds are backed by specific assets.
- Seniority — senior bonds are repaid before subordinated bonds in a liquidation.
- Covenants — conditions protecting bondholders, such as limits on further borrowing.
- Call options — allowing the issuer to repay early, usually when rates have fallen.
- Convertibility — allowing holders to convert into shares.
Credit ratings and spreads
Credit rating agencies assess the likelihood that an issuer will meet its obligations and assign ratings, from the highest grades (very low default risk) down through investment grade to speculative or "high-yield" grades. Ratings help investors compare issuers, and many institutional investors may only hold bonds above a certain grade.
The credit spread is the difference between a corporate bond’s yield and the yield on a government bond of similar maturity. It compensates for default risk, lower liquidity and other features. Spreads widen when the economy weakens or investors become more cautious. Ratings are opinions, not guarantees — they can lag events and have been wrong in past crises.
Why investors buy bonds
- Predictable income from coupons.
- Capital preservation when held to maturity from a sound issuer.
- Diversification — high-quality bonds have often behaved differently from shares, especially in downturns; see diversification and asset allocation.
- Matching liabilities — pension funds and insurers match long-term obligations with long-term bonds.
Risks for bondholders
| Risk | Description |
|---|---|
| Interest rate risk | When market rates rise, existing bond prices fall; longer bonds are more sensitive |
| Credit (default) risk | The issuer may miss coupons or principal |
| Inflation risk | Fixed coupons lose purchasing power when inflation rises |
| Liquidity risk | Some bonds trade rarely, so selling before maturity may require a price discount |
| Reinvestment risk | Coupons may have to be reinvested at lower rates |
| Call risk | The issuer may repay early when rates fall, ending high coupons |
| Currency risk | For bonds in a foreign currency |
The inverse relationship between price and yield is the key to understanding bond markets; bond pricing and yield explains it with examples, including duration, the main measure of interest rate sensitivity.
Bonds compared with shares
| Bonds | Shares | |
|---|---|---|
| Nature | Debt — a loan to the issuer | Equity — ownership |
| Income | Contractual coupons | Dividends at the board’s discretion |
| Repayment | Face value at maturity | None — sell in the market |
| Priority in liquidation | Ahead of shareholders | Last |
| Upside | Limited (mainly coupons and price gains if rates fall) | Potentially unlimited |
| Volatility | Generally lower | Generally higher |
Common mistakes
- Treating the coupon rate as the return regardless of the price paid.
- Assuming bonds cannot lose value — prices fall when rates rise or credit quality weakens.
- Ignoring liquidity for bonds that rarely trade.
- Relying solely on credit ratings without understanding the issuer.
Key terms
- Coupon — the periodic interest payment on a bond.
- Face value — the amount repaid at maturity.
- Maturity — the date when the face value is repaid.
- Credit rating — an agency’s opinion of an issuer’s creditworthiness.
- Credit spread — the extra yield over a comparable government bond.
Frequently asked questions
What happens if I sell a bond before maturity?
You receive the current market price, which may be above or below what you paid, depending on interest rates and the issuer’s credit quality since you bought it.
Are government bonds risk-free?
They carry very low credit risk in the government’s own currency, but their prices still change with interest rates, and inflation reduces real returns.
What is a zero-coupon bond?
A bond that pays no coupons and is issued at a discount; the investor’s return is the difference between the price and the face value.
Key takeaways
- A bond pays coupons and repays face value at maturity.
- Government bonds set benchmark yields; corporate bonds pay a credit spread above them.
- Ratings summarise credit risk but are opinions, not guarantees.
- Bond prices fall when interest rates rise; longer maturities are more sensitive.
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