What is a bond?
A bond is a loan that you make to a government or a company. In return they promise to pay you interest regularly and give your money back on a fixed date.
The vocabulary of a bond
The most important rule: prices and interest rates move in opposite directions
Imagine you hold the 5% bond above. Next day, interest rates rise and new bonds pay 6%. Nobody would pay you $1,000 for a bond paying only $50 when a new one pays $60. Your bond's price must fall until its return matches 6%:
The return a buyer gets at today's price is called the yield (more precisely, yield to maturity). When the news says "bond yields rose", it means bond prices fell. Longer bonds react more strongly to rate changes; this sensitivity is called duration.
Real example: in 2022, central banks raised rates quickly to fight inflation, and long-term government bonds, usually seen as "safe", suffered some of their worst price falls in decades. Safe from default does not mean safe from price swings.
Credit risk and ratings
The other big risk is that the borrower cannot pay (default). Agencies such as S&P, Moody's and Fitch grade borrowers:
| Rating (S&P style) | Meaning | Interest demanded |
|---|---|---|
| AAA, AA | Very strong (e.g. Germany, Microsoft) | Lowest |
| A, BBB | Good to adequate. BBB− is the lowest "investment grade"; Romania's government has been rated around this level | Moderate |
| BB, B | "High yield" or "junk": speculative | Higher |
| CCC … D | Very risky … in default | Very high |
Defaults happen even to countries: Greece restructured its debt in 2012, and Argentina has defaulted several times in its history.
Kinds of bonds
| Government bonds | US Treasuries, German Bunds, Romanian government bonds (including Fidelis and Tezaur for individuals). The yield on 10-year government bonds is used as the risk-free rate in valuation (DCF lesson). |
| Corporate bonds | Issued by companies; pay more than government bonds because of credit risk. |
| Municipal bonds | Issued by cities and regions. |
| Inflation-linked bonds | Repayments rise with inflation (e.g. US TIPS). |
| Zero-coupon bonds | No yearly interest; bought below face value and repaid at face value. |
Stocks vs bonds
| Stock | Bond | |
|---|---|---|
| You are | An owner | A lender |
| Income | Dividends, if the company decides to pay | Fixed coupons, a legal obligation |
| At the end | No end date | Face value repaid at maturity |
| If things go wrong | Paid last | Paid before shareholders |
| Upside | Unlimited | Limited to coupons (+ a price gain if rates fall) |
Show the answer
Down. Your 3% bond is less attractive than new 5% bonds, so buyers will only take it at a lower price. If you hold it until maturity you still get the full face value back.