What Are Bonds and How Do They Work?

What are bonds and how do they work?

Short answer: Bonds are debt securities issued by governments, companies or other organisations to borrow money. Investors typically receive interest payments and repayment of the bond’s face value at maturity, provided the issuer meets its obligations. Many bonds can be sold earlier, but their market prices fluctuate, so investors can lose money.

What is a bond?

A bond is a debt security: a financial claim on money owed by its issuer.

Governments issue bonds to finance spending or refinance existing debt. Companies use them to fund operations, investment or other borrowing needs.

A bondholder is a creditor. Buying a company’s bond does not give the investor an ownership stake in that company.

These terms explain the basic structure:

Face value and purchase price are not necessarily equal. A bond with a $1,000 face value may trade above or below $1,000.

How does a bond work in practice?

A conventional fixed-rate bond has a payment schedule established when it is issued.

Consider a hypothetical bond with:

1. Face value: $1,000.
2. Purchase price: $1,000.
3. Annual coupon rate: 4%.
4. Maturity: five years.
5. Interest payments: once a year.

The annual coupon is:

$1,000 × 4% = $40

Assuming the issuer makes every payment and does not redeem the bond early, the investor receives $40 each year for five years. At maturity, the issuer also repays the $1,000 face value.

Total scheduled cash received is:

$200 in coupons + $1,000 principal = $1,200

The $1,000 repayment is the return of principal. The $200 represents interest earned before taxes and costs, excluding any income from reinvesting the coupons.

Payment schedules vary. For example, conventional US Treasury notes pay interest every six months.

What types of bonds are there?

Bonds can be grouped by issuer and by payment structure. These categories overlap: a government bond can also be fixed-rate or inflation-linked.

Corporate bonds are also classified by credit quality. Investment-grade bonds have higher credit ratings than high-yield bonds. A higher offered yield may compensate investors for greater default risk; it does not make the investment automatically more attractive.

How do coupon rates and bond yields differ?

The coupon describes the bond’s contractual interest payments. Yield relates those payments, and sometimes principal repayment, to the price an investor pays.

For the $1,000 bond paying $40 annually:

The coupon remains $40 in every case. The current yield changes because the purchase price changes.

Yield to maturity also accounts for the scheduled repayment of face value. Buying below face value creates a potential gain at maturity; buying above face value creates a potential loss on that repayment.

YTM assumes scheduled payments occur. Achieving an equivalent compounded return also depends on coupon reinvestment rates. Taxes, fees, default and an early sale can change the investor’s actual result.

Why do bond prices fall when interest rates rise?

Existing fixed-rate bonds must compete with the returns available on comparable investments.

Suppose an older bond pays a 4% coupon while similar newly issued bonds offer 5% at face value. Buyers will generally require a lower price for the older bond to compensate for its smaller payments.

The reverse can happen when market yields fall: an existing bond with a comparatively attractive fixed coupon may rise in price.

For a conventional bond with unchanged promised cash flows:

Higher price → lower yield. Lower price → higher yield.

The size of the price movement depends partly on duration, a measure of sensitivity to yield changes. Higher-duration bonds generally experience larger percentage price changes for the same change in yield.

A central bank’s policy rate is only one influence. Inflation expectations, credit concerns, investor demand and expectations of future rates also affect bond prices.

What does a US 10-year Treasury yield of 5.28% mean?

On 1 October 2026, market reporting placed the US 10-year Treasury yield at approximately 5.28%.

This is a dated market observation. The yield changes as the market reprices government debt.

The figure refers to an annualised market yield associated with the 10-year Treasury benchmark. It does not mean:

1. Every Treasury security pays a 5.28% coupon.
2. The bond’s price has risen by 5.28%.
3. An investor selling next month will earn 5.28%.
4. The Federal Reserve’s policy rate is 5.28%.

The security commonly called the “10-year Treasury bond” in everyday discussion is formally a Treasury note. US Treasury notes are issued with maturities from two to ten years; Treasury bonds are issued for twenty or thirty years.

For an existing fixed-rate note, changing market yields do not alter its contractual coupon.

Can you sell a bond before maturity?

Many marketable bonds can be sold before maturity, provided a buyer is available. The sale price may be higher or lower than the purchase price.

Using the earlier example, suppose an investor:

1. Pays $1,000 for the bond.
2. Receives one $40 coupon.
3. Sells immediately after that payment for $960.

The result before taxes and costs is:

$40 interest + $960 sale proceeds − $1,000 purchase price = $0

If the sale price were $920, the result would instead be a $40 loss.

Receiving interest therefore does not guarantee a positive total return.

The examples assume a sale immediately after a coupon payment. Between payment dates, settlement commonly includes accrued interest—the interest accumulated since the previous coupon.

What are the main risks of bonds?

Bonds carry several risks, even when their scheduled payments are fixed.

Holding a bond to maturity avoids having to sell at an unfavourable market price, but it does not remove default, inflation or currency risk.

It also does not guarantee recovery of the purchase price. If an investor pays $1,050 for a conventional bond with a $1,000 face value, its scheduled principal repayment is $1,000.

How do investors buy bonds?

Investors can buy individual bonds at issuance or through the secondary market, subject to availability and eligibility.

At issuance, investors provide financing to the issuer. In a secondary-market transaction, the buyer normally pays the previous holder and takes over the remaining payment rights.

Another route is a bond mutual fund or exchange-traded fund. Investors own shares or units in a portfolio rather than one individual bond.

A conventional bond fund generally has no single maturity date at which the investor is promised repayment of a fixed face value. Its value changes with its holdings and market conditions.

Access methods, minimum purchases and dealing costs vary by provider and jurisdiction.

Why do bond yields matter to forex, gold and index traders?

Government bond yields are reference points for financing costs and investment returns across markets.

For readers of NordFX’s market analysis, understanding yields helps explain developments beyond the bond market.

1. Currencies: changes in relative yields can influence the appeal of holding assets in different currencies. Exchange-rate expectations and risk sentiment also matter.
2. Gold: higher real yields—yields adjusted for inflation expectations—can increase the opportunity cost of holding gold, which pays no interest.
3. Stock indices: higher yields can raise financing costs and reduce the present value investors assign to future company earnings.

These relationships are conditional. A rise in Treasury yields does not automatically mean a stronger dollar, weaker gold or falling stocks.

Understanding why yields changed is more useful than treating the yield movement as a standalone trading signal.

What mistakes should beginners avoid?

Common mistakes include:

1. Treating coupon and yield as interchangeable. One describes contractual interest; the other depends on price and the yield measure used.
2. Assuming face value equals purchase price. Bonds can trade at a premium or discount.
3. Ignoring losses when selling early. Coupon income may be smaller than the decline in market value.
4. Choosing only the highest yield. Extra yield may reflect greater credit risk or restrictive terms.
5. Assuming all government bonds have the same risk. Issuers, currencies and maturities differ.
6. Confusing a bond fund with an individual bond. Their repayment structures are different.
7. Reading a market headline as a promised return. A benchmark yield is a market measure, not a personal investment outcome.

Frequently asked questions

How do you make money on bonds?

Returns can come from coupon payments and from selling or redeeming a bond for more than its purchase price. Zero-coupon bonds typically provide their return through the difference between purchase price and repayment. Defaults, price declines, costs and taxes can reduce or eliminate gains.

Can you lose money on bonds?

Yes. Losses can occur through default, an early sale below purchase price or adverse currency movements. Inflation can also reduce purchasing power even when the issuer makes every scheduled payment.

Are bonds a good investment?

Their suitability depends on the investor’s objectives, time horizon, currency needs and tolerance for risk. Bonds can provide income and diversification, but their credit quality, price, maturity and terms must be assessed. They are not automatically suitable because they pay interest.

How much is a $100 bond worth after 30 years?

There is no universal answer. It depends on the bond type, face value, coupon, purchase price and repayment terms. A conventional bond with a $100 face value normally repays $100 at maturity if the issuer meets its obligations, with coupons paid separately. Savings bonds may follow different rules.

Do bonds pay interest every month?

Some do, but payment frequency varies. Other bonds pay quarterly, semiannually or annually. Zero-coupon bonds make no regular interest payments. The bond’s terms specify its payment schedule.

What is the difference between bonds and shares?

A bond represents debt owed by an issuer. A share represents ownership in a company. Bondholders generally rank ahead of shareholders in insolvency, although recovery is not assured and depends on the debt’s ranking and available assets.

What should you remember about bonds?

Understanding a bond starts with three questions: what payments are promised, what price are you paying, and what could prevent you from receiving those payments?

Coupon, yield and total return answer different questions. Keeping them separate makes it easier to assess a bond and interpret market headlines about Treasury yields, interest rates and changing asset prices.