Bond
A debt security: the issuer pays coupons, then repays at maturity.
A loan cut into securities
A bond is a slice of debt. The issuer (a state, a company) borrows a sum, the face value, pays a fixed interest every year, the coupon, and repays the face value at maturity. The bond then trades on the market at a price that changes every day.
Price and yield move in opposite directions
If market rates rise, an older bond paying a lower coupon becomes less attractive: its price falls until its yield matches the market. Conversely, when rates fall, existing bonds gain value. The size of the move depends on duration.
Credit risk
Lending to Germany or the US is deemed free of default risk; lending to a fragile company is not. Rating agencies grade issuers from AAA to D, and the extra yield demanded above government debt, the credit spread, measures that risk.
A 3% bond when rates go to 4%
- €1,000 bond, 3% coupon (€30 a year), 5 years to maturity.
- New bonds yield 4%. To be equivalent, the old one must cost the present value of its cash flows at 4%.
- 30/1.04 + 30/1.04² + 30/1.04³ + 30/1.04⁴ + 1,030/1.04⁵ = €955.48.
The price falls about 4.5% for a one-point rise in rates.
2022, the worst bond year in decades
With the sharp rise in rates, the global bond index lost about 16% in 2022 and US Treasuries of 20+ years about 30%. “60% stocks, 40% bonds” portfolios had one of their worst years as both asset classes fell together.
Common mistakes
- Believing a bond cannot lose: its price falls when rates rise, even without default.
- Confusing coupon and yield: the yield depends on the price paid.
Notitia newsroom · education, not investment advice.