Bonds: The Loan Receipt You Can Trade

A bond is a debt security, which is a formal IOU. When you buy one, you lend money to the issuer, and the issuer can be a company, a government, or a local government. In return, the issuer promises to pay a stated rate of interest during the bond's life and to repay the principal, also called face value or par value, when the bond matures. 1

Think of a bond as a loan receipt you can trade. It says who borrowed the money, what interest was promised, and when the original amount comes due. A bondholder is a lender, not an owner of the issuer, and that is the difference from owning stock in the company. 2

Three words do most of the work:

"Fixed income" can sound more certain than it is. Bonds carry credit risk, which means an issuer can fail to make its promised payments. They also carry inflation risk and liquidity risk. For a first look, the one to notice is this: the market price of a fixed-rate bond can change before maturity. When new market rates rise, an older bond with a lower fixed coupon becomes less appealing, so its sale price may fall. The reverse can happen when market rates fall. 1

That price movement matters most when a bond is sold before maturity. Investor.gov explains that a holder who keeps a bond to maturity still receives the stated interest and the face value, subject to default risk, while a seller before maturity may receive more or less than face value depending on market conditions and the bond's terms. The same bulletin adds that a government guarantee covers the scheduled payments, not the bond's market price if it is sold early. 3

The beginner map is to ask four questions before treating a bond as simple or guaranteed: who is borrowing, when the bond matures, what interest and other terms it promises, and what happens if the bond has to be sold before maturity. This episode is educational only and is not registered investment advice. It does not recommend a particular bond, fund, or strategy.