Explaining bonds for dummies

A bond is a type of investment where an investor lends money to a borrower, usually a company or government. It can be seen as a written agreement between the lender and borrower that outlines the loan terms and repayment schedule. Bonds are commonly used by various entities like companies, municipalities, states, and governments to fund their projects and day-to-day activities. People who own bonds are considered as creditors or debtholders of the entity issuing the bond. It’s Explaining bonds for dummies and I think you can understand it.

Explaining bonds for dummies in short version

A bond is a type of investment where an investor lends money to a borrower, usually a company or government.

How Bonds Work

Bonds are often called fixed-income securities and are a popular type of investment for individual investors. They are issued by companies or other entities to raise money for various purposes. When someone buys a bond, they are essentially lending money to the issuer. The bond includes details such as the loan terms, interest payments, and the date when the loaned funds must be repaid. The interest payment, also known as the coupon, is the return that bondholders receive for lending their money. The interest rate that determines the payment is called the coupon rate.

Most bonds have an initial price set at $1,000 per bond. However, the actual market price of a bond depends on factors like the issuer’s credit quality, the time until the bond matures, and the coupon rate compared to the prevailing interest rates. When the bond matures, the lender receives the face value of the bond.

After bonds are issued, the initial bondholder can sell them to other investors. This means that bondholders don’t have to hold the bond until it matures. It is also common for borrowers to repurchase bonds if interest rates decrease or their credit improves, allowing them to issue new bonds at a lower cost.

Bonds’ Characteristics

Most bonds share some common basic characteristics including:

  • Face value is the amount of money it will be worth when it matures. It is also the amount that the bond issuer uses to calculate interest payments.
  • The coupon rate the interest rate that the bond issuer will pay on the bond’s face value, shown as a percentage.
  • Coupon dates: The bond issuer will make interest payments on coupon dates. Payments can be made at any interval, but the usual practice is to make semiannual payments.
  • The maturity date is when the bond reaches its maturity and the bond issuer pays the bondholder the bond’s face value.
  • The issue price: The initial selling price of bonds is known as the issue price. Often, bonds are sold at par value.

Types of Bonds

There are four main types of bonds sold in the markets. Nevertheless, on certain platforms, you might also come across foreign bonds issued by global corporations and governments.

  • Corporate bonds
  • Municipal bonds
  • Government bonds
  • Agency bonds

Pricing Bonds

Bonds are priced based on their unique characteristics and their value can change daily, just like any other publicly traded security. The price of a bond is determined by supply and demand in the market at any given moment.

However, there is a method to valuing bonds. Previously, we discussed bonds assuming that every investor holds them until maturity. While it is true that holding a bond until maturity guarantees the return of principal plus interest, it is not necessary to do so. Bondholders have the option to sell their bonds in the open market at any time, where the price can fluctuate significantly.

The price of a bond fluctuates in response to changes in interest rates in the economy. This is because, for a fixed-rate bond, the issuer has committed to paying a coupon based on the bond’s face value. For example, a $1,000 bond with a 10% annual coupon will pay the bondholder $100 each year.

Let’s say that at the time of issuance, prevailing interest rates are also 10%, as determined by the rate on a short-term government bond. In this scenario, an investor would be indifferent between investing in the corporate bond or the government bond, as both would provide a $100 return. However, if the economy worsens and interest rates drop to 5%, the investor would only receive $50 from the government bond but still receive $100 from the corporate bond.

This difference makes the corporate bond more attractive. As a result, investors in the market will bid up the price of the bond until it reaches a premium that aligns with the prevailing interest rate environment. In this case, the bond would trade at a price of $2,000, where the $100 coupon represents a 5% yield. Similarly, if interest rates were to increase to 15%, an investor could earn $150 from the government bond and would not be willing to pay $1,000 to earn just $100. The bond would be sold until its price aligns with the yields, in this case, a price of $666.67.


After you read Explaining bonds for dummies article. You can know, bonds are less risky than stocks and are usually suggested as part of a diversified investment portfolio. When interest rates decrease, bond prices tend to increase. If bonds are held until maturity, they will repay the original amount invested along with the interest earned. This makes bonds a suitable choice for investors looking for income and capital preservation. As individuals age or near retirement, experts recommend increasing the allocation of bonds in their portfolio.