Bonds and rates

A bond is a loan with a coupon

A bond is the stock’s mirror image (Lesson 1): instead of buying a slice of a company, the bondholder lends it money — or lends it to a government — on printed terms. The terms have names worth owning. Face value: the amount lent, repaid at the end. Coupon: the interest paid along the way, traditionally clipped from the certificate’s edge (the old paper bonds carried literal coupons; the word stayed). Maturity: the date the loan comes due. The bondholder’s whole claim is those three numbers — no upside in the company’s success, and first in line (ahead of the owners) if it fails.

That seniority is the bond’s character: it trades the stock’s open-ended gain for a contracted one, and the contract’s safety depends entirely on the borrower. A government that prints its own currency is one grade of borrower; a struggling retailer is another; the market prices the difference in the coupon it demands. Bonds are not ‘the safe asset’. They are loans, each as safe as its borrower — a distinction this lesson will not let go of.

Four distinct risks ride in every bond, and naming which one you hold is the beginning of pricing it. Credit risk is the one above: the borrower fails to pay. Interest-rate risk is the see-saw of the next section: yields rise and your price falls, whether or not you ever sell. Liquidity risk is quieter: some bonds trade rarely, in thin markets where leaving means accepting a steep discount to the last quoted price — the bond can be sound and still expensive to exit. Inflation risk needs no default and no sale at all: a 5% coupon in a world of 6% inflation hands you back cheaper money every year — the contract kept to the letter, the purchasing power gone. A bond can dodge any one of these and be fully exposed to the other three.

Price and yield move against each other

Here is the mechanic that confuses every first reader, stated as arithmetic. You hold a bond paying a 5% coupon: $50 a year on $1,000 of face. New bonds are now issued at 6% — $60 a year for the same $1,000. Who pays full price for your $50 stream when $60 is available next door? Nobody: your bond’s price falls until its $50 coupon, plus the gain to face value at maturity, competes with the new 6% world. Yields up, prices down — not a mood, a see-saw built into the instrument. And the see-saw’s violence scales with time: a thirty-year stream of now-uncompetitive coupons must be discounted far harder than a two-year one. Long bonds are the interest-rate market’s high ground.

The measure of that violence has a name: duration. Maturity only states when the last payment arrives; duration weighs every payment by when it arrives and gives the bond an effective center of gravity, in years — and, in the form traders use (modified duration), the approximate percentage the price moves for each one-point move in yield. A ten-year bond paying a 5% coupon has a duration near 8 — which is where this lesson’s rule of thumb comes from: one point of yield, roughly 8% of price. But two bonds of the same ten-year maturity can carry different durations: a small coupon pushes the bond’s weight toward the final payment, lengthens duration, and deepens the fall; a large coupon pulls payments earlier, shortens duration, and softens it. Maturity alone cannot tell you how hard a bond falls. Duration can.

The worked example prices the see-saw for one bond at three yield worlds. Keep its shape: a single percentage point of yield, on a ten-year bond of middling coupon — duration near eight — is worth roughly 8% of price. Rates are not background music to a bond portfolio. They are the price.

Three yield words circulate around every bond, and this lesson keeps them separate. The coupon rate never changes: 5%, $50 a year on $1,000 of face, printed at issue. The current yield is that same $50 divided by the price you would pay today — about 5.4% at the fallen price of $926 in the example below, about 4.6% at the risen price of $1,081. And yield to maturity is the full accounting: the annualized return if you buy at today’s price, collect every coupon, and are repaid the face value at the end — coupons plus the slow pull of a discounted price back up to par, or a premium price down to it. It is the number the worked example calls the prevailing yield: the old bond’s price falls to $926 precisely so that a buyer’s yield to maturity becomes the new 6%. Current yield counts only the coupons; yield to maturity counts everything, which is why it is the comparison that matters — and it is a held-to-maturity figure, not a promise: sell earlier, and the see-saw, not the schedule, decides your return.

The 10-year is gravity

One yield gets quoted on the journal’s tape every morning, beside the futures: the 10-year, the rate on the benchmark government loan. It earns the slot because it is the rate the whole economy’s arithmetic leans on — mortgages price off it, corporate borrowing prices off it, and (Lesson 8’s connection) stock valuation quietly prices off it too. The link runs through discounting: a stock’s price is, in the textbooks’ phrase, future earnings brought back to today at some rate — and when the 10-year rises, the bringing-back gets harsher, distant earnings shrink in today’s dollars, and the multiples investors will pay compress, hardest on the companies whose earnings are furthest away.

This is why growth stocks fall on rising-rate days without a word of company news, and why the tape chip you have been reading since Folder 2 is a stock-market fact, not a bond-market footnote. The investor’s translation is simple: the 10-year is the price of time itself in the market. When time gets expensive, everything whose price depends on patience gets cheaper.

Where bonds sit in a working portfolio

For this track’s reader, bonds usually play one role: ballast. A portion of the portfolio held as high-grade, shorter-maturity loans whose prices move less than stocks’ and whose coupons arrive on schedule — there to be rebalanced from in a stock drawdown (Lesson I4’s mechanics) and to hold the money that has a date attached to it (a house deposit in three years has no business in equities at all, whatever their expected return: horizon is the allocation’s first question, and I4 builds on exactly that).

None of which makes bonds a hiding place from thought. Their prices move (the see-saw), their borrowers can fail (the mirror of Lesson 1’s ownership risk), and a long-maturity bond fund in a rising-rate year can lose stock-like percentages with none of the stock’s recovery story. Owning the loan directly and owning it through a fund are the same credit wearing different mechanics. An individual bond held to maturity returns its face on a known date, borrower permitting: the see-saw swings its price in between, but a holder who does not sell need not realize the swing, and its duration shortens as the date approaches. A bond fund holds hundreds of loans and continually replaces them, so the fund itself never matures — its duration is maintained rather than spent down, and there is no morning on which it hands you par. In exchange the fund offers diversification across borrowers, trading in markets where single bonds are awkward for an individual to buy, and daily liquidity. Neither is the safer instrument in the abstract; they retire different risks, and the choice belongs on the plan page (Lesson I6), next to the money’s date.

The vehicle was missing from Folder 4’s tour because it deserved its own lesson, not because it is simple. You now hold its mechanics: coupon, price, current yield and yield to maturity, duration, the see-saw, and gravity.

Where this breaks

Yield to maturity is a held-to-maturity figure: it assumes every coupon arrives and the bond is kept to the end — and, quietly, that coupons are reinvested at that same yield. Sell early and the see-saw sets your return instead. Duration, likewise, is an approximation tuned for small moves; large yield jumps bend the price by less than the straight-line estimate, which is a kindness, not a precision tool. And a bond fund never hands you a maturity date at all — its duration is maintained, so its see-saw never switches off.

Practice

A fictional bond: face $1,000, a 5% annual coupon, a market price of $926, and a modified duration of about 8. (1) The coupon in dollars, and the current yield. (2) Yields rise by one percentage point: estimate the new price from duration, and name the kind of risk that just moved. (3) Sort the rest: the issuer’s finances weaken badly; you must sell quickly into a thin market; the general price level rises while the coupon stays fixed. Name the distinct risk in each.

Answers: (1) $50 a year; current yield = 50 ÷ 926 ≈ 5.4%. (2) About 8% lower — roughly $852 — and that is interest-rate risk, arriving through duration, not through the issuer. (3) Credit risk; liquidity risk; inflation risk — three different failures with three different defenses, which is why this lesson keeps them separate.

Sources

Sources: the terms of Treasury bills, notes, bonds and TIPS — what they are, how they are sold, and how their interest is paid — are published by the U.S. Department of the Treasury at TreasuryDirect (treasurydirect.gov), the Treasury’s own site for those securities. Checked October 2026. The bonds in this lesson are hypothetical teaching examples; the Treasury’s pages carry the terms in force.