Economics
Bonds (Financial)
Quick fact
The global bond market is over $100 trillion in size, dwarfing the stock market. Most bonds are traded over-the-counter, not on public exchanges like stocks.
Why this is interesting
You probably know about borrowing money from a bank. But what if a government needs billions to build a bridge? Instead of a single loan, it issues bonds—thousands of small loans to investors. Why would anyone lend money to a government or company through a bond?
Read the full explanation
Understanding Bonds (Financial)
A bond is essentially an IOU. When you buy a bond, you are lending a fixed amount of money (the principal or face value) to the issuer for a set period (the maturity date). In return, the issuer promises to pay you periodic interest payments (the coupon) at a fixed rate. At maturity, you get back your original principal. For example, a 10-year bond with a $1,000 face value and 5% coupon pays $50 every year, then $1,000 at the end. Bonds are safer than stocks because they guarantee repayment unless the issuer defaults, but returns are typically lower. The price of a bond fluctuates in the secondary market inversely with interest rates: when rates rise, existing bond prices fall because newer bonds offer higher coupons.
A deeper explanation
The mechanism behind bond pricing and yield is central to understanding debt markets. The price of a bond is equal to the present value of all future cash flows (coupons and principal) discounted by the prevailing interest rate. This relationship explains why bond prices move inversely to interest rates—a concept known as interest rate risk. The yield to maturity (YTM) is the total return an investor expects if the bond is held to maturity, accounting for price, coupon, and time. Bonds are crucial for governments to fund deficits, infrastructure, and social programs, and for companies to raise capital without diluting ownership. They also serve as a benchmark for other interest rates, influencing mortgages, auto loans, and corporate borrowing costs. Without bonds, the modern financial system would lack a foundational tool for raising long-term capital.