What is Bond?

A bond is a fixed-income debt security that represents a formal loan made by an investor to a borrower, typically a sovereign government, local municipality, or private corporation. Under the terms of a bond agreement, the issuer borrows capital from the investor and contractually promises to make regular, periodic interest payments (known as coupon payments) at a set rate (the coupon rate) throughout the life of the bond. Additionally, the issuer agrees to return the original principal balance (the face value or par value) on a specified future date, known as the maturity date. Bonds are traded on secondary markets, allowing investors to sell their debt holdings before maturity.

Bonds are categorized by their issuing entity and default risk. U.S. Treasury bonds are issued by the federal government and backed by its 'full faith and credit,' representing virtually zero default risk. Municipal bonds are issued by state and local governments to finance public infrastructure and frequently offer interest income that is exempt from federal (and often state/local) income taxes. Corporate bonds are issued by corporations to fund capital investments; they carry higher default risk and are graded by credit rating agencies (such as S&P, Moody's, and Fitch) into investment-grade or high-yield ('junk') classifications. Because bond coupon rates are fixed, bond market prices share an inverse relationship with interest rates: when market interest rates rise, existing bond prices fall, whereas falling interest rates cause bond prices to increase.