What Is a Bond? Fixed-Income Investing Explained

A bond is a loan you make to a borrower — a government, municipality, or corporation — in exchange for a promise: regular interest payments over a fixed term, and repayment of the original amount, called the principal or face value, when the bond matures. Unlike buying a stock, which makes you a part owner of a company with no promised return, buying a bond makes you a creditor with a contractually defined payout schedule. That difference is the foundation of the entire fixed-income asset class.

The mechanics of a bond

Every bond has a handful of defining terms:

• Face value (par value). The amount the issuer repays at maturity, commonly $1,000 for individual bonds. This is also the amount interest payments are calculated on.
• Coupon rate. The fixed annual interest rate paid on the face value. A $1,000 bond with a 4% coupon pays $40 a year, typically split into semiannual payments.
• Maturity date. When the issuer repays the face value and the bond ceases to exist. Terms range from a few months (Treasury bills) to 30 years or more.
• Yield. The actual return an investor earns, which moves with the bond’s market price and differs from the coupon rate whenever the bond trades above or below face value.

If you buy a newly issued $1,000 bond at face value with a 4% coupon and hold it to maturity, your yield equals the coupon rate: 4%. But bonds trade in a secondary market before maturity, and their price moves — which is where yield and coupon rate diverge.

Why bond prices move inversely to interest rates

This is the single most important relationship in fixed income, and it trips up a lot of new investors: when prevailing interest rates rise, existing bond prices fall, and vice versa.

The logic is straightforward. Say you hold a bond paying a fixed 4% coupon, and new bonds start being issued at 6% because rates rose. Your bond’s fixed $40-a-year payment is now less attractive than a new bond paying $60 a year on the same $1,000 face value. For anyone to want to buy your bond instead of a new one, its price has to drop enough that the $40 payment represents a competitive yield — meaning your bond now trades below face value. The reverse happens when rates fall: your fixed coupon looks relatively better, and the bond’s price rises above face value.

This is why a bond’s price and its yield to maturity — the total return an investor gets if they buy at the current market price and hold to maturity, accounting for both coupon payments and any difference between purchase price and face value — move in opposite directions.

Types of bonds

Issuer	Example	General risk level
National government	U.S. Treasury bonds	Very low (backed by the issuing government)
Municipality	State or city bonds	Low to moderate
Investment-grade corporation	Large, financially stable companies	Moderate
High-yield (“junk”) corporation	Lower-rated companies	Higher, compensated by higher coupons

Government bonds from stable, currency-issuing nations are generally considered the lowest-risk end of the spectrum because default risk is minimal. Corporate bonds pay higher coupons to compensate for the added risk that the company might struggle to make payments or repay principal at all — a risk captured in credit ratings from agencies like Moody’s and S&P, where lower ratings mean higher perceived default risk and, correspondingly, higher yields demanded by investors.

Bonds vs. stocks

Bonds and stocks sit at different points on the risk-and-return spectrum, and understanding the contrast clarifies what each one is actually for.

	Bonds	Stocks
What you own	A creditor claim (a loan)	An ownership stake
Return type	Fixed, scheduled interest	Variable, tied to company performance
Priority in bankruptcy	Paid before shareholders	Paid last, after all creditors
Typical volatility	Lower	Higher
Upside	Capped at coupon + principal	Theoretically unlimited

Because bondholders are creditors, they get paid before shareholders if a company goes bankrupt — one reason bonds are generally considered lower risk than owning the same company’s stock. That safety comes at the cost of upside: a bond can never pay more than its coupon and principal, no matter how well the issuer performs, while a stock’s market cap can grow without limit.

How individual investors access bonds

Buying individual bonds directly requires meaningful capital and comes with less liquidity than buying stocks. Most individual investors instead access fixed income through a bond ETF or mutual fund, which pools many bonds together and trades as a single security throughout the day. This diversifies default risk across many issuers and adds liquidity, at the cost of the fund’s value fluctuating with the bond market rather than offering a fixed date to get your principal back. Investors building a diversified portfolio over time often apply dollar-cost averaging to bond funds the same way they would to stock funds, buying at regular intervals regardless of price.

The takeaway

A bond is a loan with defined terms: a coupon rate, a face value, and a maturity date. Its price moves inversely to prevailing interest rates because a fixed coupon becomes more or less attractive as new bonds are issued at different rates. Bonds generally carry less risk and lower expected return than stocks — bondholders get paid before shareholders, but their upside is capped at the coupon and principal — which is why they’re typically used to balance a portfolio rather than to chase growth.