Bonds Explained
What is a Bond?
Think of a bond as you being the bank. When you buy a bond, you're lending money to a government or company. In return, they promise to:
- Pay you interest (called the coupon) regularly
- Return your principal (the original amount) at the end
That's it. You lend money, you get paid interest, you get your money back.
Key Terminology
- Coupon - The interest payment you receive. It's fixed when the bond is issued and never changes. (e.g., 5% = €50/year on €1,000 face value)
- Maturity - When the bond expires and you get your principal back
- Face Value - The amount you'll get back at maturity per bond (usually €1,000 or €100). Face value is fixed and never changes. What changes is the market price (what people pay for the bond right now). At maturity, you always get the face value back, regardless of what you paid. So if you buy 10 bonds with €1,000 face value each, you'd get €10,000 back at maturity (plus the coupon payments along the way)
- Yield - Your percentage return based on what you paid. Yield changes based on the market price. Example: A bond with €50 coupon and €1,000 face value has a 5% coupon rate. But if you buy it for €900, your yield is 5.5% (€50/€900) - higher because you paid less.
- Credit Rating - A grade given by rating agencies (like S&P, Moody's, Fitch) that tells you how likely the issuer is to pay you back. Think of it like a credit score for companies and governments:
- AAA to BBB = Investment grade (safer, lower returns)
- BB and below = High-yield or speculative grade (riskier, higher returns) - informally called "junk" bonds
Types of Bonds
Government Bonds
- Issued by governments to fund spending
- Generally the safest option
- Lower returns, but very reliable
- Examples: US Treasury, German Bunds
Corporate Bonds
- Issued by companies to raise capital
- Higher risk than government bonds
- Higher returns to compensate for risk
- Rating matters: Apple bond vs startup bond = very different risk
Municipal Bonds
- Issued by local governments (cities, states)
- Often tax-advantaged
- Fund local projects (schools, roads)
High-Yield (Junk) Bonds
- Bonds with low credit ratings (BB or below)
- Highest risk, highest potential return
- Called "junk" but can be profitable if you understand the risk
Inflation-Linked Bonds
- Face value and interest payments adjust with inflation
- Protects your purchasing power over time
- Lower initial yield than regular bonds, but safer against inflation
- Examples: US TIPS (Treasury Inflation-Protected Securities), German inflation-linked Bunds
Risks vs Benefits
| Benefits | Risks |
|---|---|
| Predictable income stream | Interest rate risk (prices fall when rates rise) |
| Less volatile than stocks | Inflation risk (fixed payments lose purchasing power) |
| Capital preservation | Credit risk (issuer might default) |
| Diversification for portfolio | Lower returns than stocks long-term |
Note: Interest rate risk only matters if you sell before maturity - if you hold until the end, you still get your face value back.
When to Consider Bonds
- Nearing retirement - Preserve capital, reduce volatility
- Need stable income - Predictable interest payments
- Diversification - Bonds often move opposite to stocks
- Risk reduction - Lower portfolio volatility
Key Takeaways
- Bonds = you lend money, you get interest + principal back
- Government bonds are safest, corporate bonds pay more but riskier
- Bond prices fall when interest rates rise (and vice versa)
- Bonds add stability to a portfolio but typically return less than stocks long-term
Not financial advice. Always do your own research.
Last updated: January 2026