Bond Yields Explained
Bonds are debt instruments where you lend money to a government or corporation in exchange for regular interest payments (coupons) and return of principal at maturity. Bond yields measure the return you'll receive. Current yield divides annual coupon by current price. Yield to maturity (YTM) accounts for both coupon payments and capital gain/loss if held to maturity.
Bond prices and yields move inversely. When interest rates rise, existing bond prices fall (because new bonds pay higher rates). When rates fall, existing bond prices rise. Buying a $1,000 face value bond at $950 means you're buying at a discount, which increases your yield beyond the stated coupon rate. The opposite occurs when buying at a premium above face value.
Bonds provide portfolio stability and income. They're less volatile than stocks and provide predictable cash flows. However, bonds face risks: interest rate risk (price drops when rates rise), credit risk (issuer might default), and inflation risk (fixed payments lose purchasing power). Diversify across issuers, maturities, and credit qualities to manage risk. Bond funds offer instant diversification but charge fees.
Quick Tips
- Always compare APR, not just interest rates
- Use the Rule of 72 to estimate doubling time
- Extra payments dramatically reduce total interest
Frequently Asked Questions
Coupon rate is the fixed interest rate paid on face value. Yield considers what you actually paid for the bond. If you buy below face value, your yield exceeds the coupon rate. Above face value, yield is lower than coupon.
No. Treasury bonds are very safe (backed by US government) but face interest rate risk. Corporate bonds face both interest rate and credit risk. Even bonds can lose value if you sell before maturity when rates have risen.
Individual bonds provide certainty - you get par value at maturity if held. Bond funds offer diversification and liquidity but fluctuate in value and may have fees. Laddered individual bonds suit those wanting predictable income.
Rising rates make new bonds more attractive, so existing bond prices fall. If you hold to maturity, you still get face value. If you sell early, you'll receive less than you paid. Shorter-maturity bonds are less sensitive to rate changes.
A strategy of buying bonds with staggered maturities (e.g., 1, 2, 3, 4, 5 years). As each matures, reinvest in a new 5-year bond. This provides annual liquidity while maintaining higher yields of longer-term bonds.