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Education

Bonds 101: The What and Why of Bond Investing

What you will learn
  • How a bond works
  • The evolution of the market and the key categories of bonds

What is a bond?

At the most basic level, a bond is a fixed income investment representing a loan made by an investor to a borrower, which includes governments, companies, and other entities issuing bonds to raise money from investors when they need new sources of capital to fund their activities.
When investors purchase a government bond, they are effectively lending the government money. When investors buy a corporate bond, they are lending a company money.

Like a loan, a bond pays a periodic interest payment known as a coupon to the bondholder. At the end of the bond's life – called maturity – the principal is paid back to the investor.

Bond investing example

A company wants to build a new manufacturing plant that will cost $1 million. To raise the money needed, company executives decide to issue a corporate bond. Each bond will be issued at $1,000 – this is known as the face value of the bond.

The company – or bond issuer – offers a coupon of 5% per year to be paid quarterly. The bonds will mature after five years, at which time the company will repay the $1,000 face value to each bondholder.

Are bonds and fixed income the same?

Basically, yes. The term fixed income is often used interchangeably with the term bonds. This is because bonds are the most commonly known type of fixed income security.

Technically, “fixed income” covers any security where the issuer is obligated to pay the lender fixed payments at fixed times. What can be confusing for investors is that fixed income does not always mean the bond pays a fixed dollar amount as bonds can have a fixed rate or floating rate. The word 'fixed' in fixed income refers to the obligation to make payments at set times.

Various bond types

Broadly speaking, government bonds and corporate bonds remain the largest sectors of the market. The chart below provides an overview of the key categories of bonds through a potential risk/return lens.

Risk-Return Profiles: Various Bond Types

A chart provides an overview of the key categories of bonds through a potential risk/return lens. The Y-axis represents risk, and X-axis shows return. Four asset classes of bonds are arranged along the graph in terms of increasing risk and return. Government bonds are generally considered low-risk investments, and are plotted in the bottom left-hand corner, with low risk and low returns relative to other bond classes. Next are quasi-government bonds, plotted a little higher and to the right, followed along the same slope by corporate bonds investment grade. Corporate bonds speculative grade have the highest risk and return potential, and are positioned in the upper right-hand corner of the graph.
For Illustrative Purposes Only

Market Value Today: Stocks Versus Bonds

The figure shows two tear-shaped graphics pointing downwards, used to compare the relative sizes of the global bond and stock markets. The graphic on the left, in blue, shows a global bond market with a value of $130 trillion. To the right is a similar image, slightly smaller and shaded in green, representing a global stock market, with a value of $101 trillion.
For Illustrative Purposes Only

Data Source: SIFMA 2023 Capital Market Factbook

Glossary of Key Investment Terms

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