02 — Markets · Core
Fixed Income, Credit & Rates
In brief
- A bond is a loan you can trade. You lend money, collect interest, and get your principal back at maturity.
- Bond prices and interest rates move in opposite directions. This single fact explains most of the bond market.
- Yield is your real return; credit risk is the chance you don't get paid back. Higher risk demands higher yield.
- The bond market is far larger than the stock market, and its signals — the yield curve, credit spreads — drive everything else.
Stocks get the headlines, but the bond market is bigger, older, and arguably more important — it sets the cost of money for governments, companies, and you. This lesson demystifies fixed income: what a bond is, the counter-intuitive way its price works, and how the signals from this market ripple across all the others.
What a bond is
A bond is a tradable loan. When a government or company needs money, it can issue bonds — IOUs sold to investors. In return the issuer promises to pay regular interest (the coupon) and to repay the original amount (the principal, or face value) on a set date (maturity). Buy a 10-year bond paying 5% and you collect 5% a year for a decade, then get your money back. Unlike a private loan, you can sell the bond to someone else before maturity — and that's where prices come in.
The most important rule in bonds
Bond prices move opposite to interest rates. Here's why. Suppose you own a bond paying 5%. If new bonds start paying 7%, no one will pay full price for your 5% bond — they'd buy the new ones. So your bond's price falls until its effective return matches the market. If new bonds pay only 3%, your 5% bond becomes more attractive and its price rises. Existing bond prices constantly adjust so their return lines up with prevailing rates. This inverse relationship is the foundation of the entire market.
Yield: the real return
Because price moves, the coupon alone doesn't tell you your return. Yield does — it's the actual return based on what you pay. The key measure, yield to maturity, captures total return if you hold to the end, blending coupon income and any gain or loss versus face value. When people say "yields rose," they mean returns on offer went up — which, by the rule above, means prices fell.
How sharply a bond's price reacts to rate changes is called duration: longer-dated bonds are far more sensitive. A small rate move barely touches a 2-year bond but can swing a 30-year bond hard. Duration is the main risk dial in a bond portfolio.
Credit risk: will you get paid?
The other great risk is that the borrower doesn't pay you back — credit risk. A government that prints its own currency is considered nearly risk-free; a shaky company is not. The market prices this difference as a credit spread: the extra yield a risky borrower must offer over a safe one. Rating agencies grade bonds from high-quality investment grade down to risky high yield ("junk"). More risk, more yield — the iron law again. Widening spreads are a classic warning that markets are turning fearful.
The yield curve: the market's crystal ball
Plot the yields of government bonds across maturities — 3 months to 30 years — and you get the yield curve. Normally it slopes upward: longer loans pay more, compensating for time and uncertainty. Its shape is one of the most watched signals in finance:
- Steep curve — markets expect growth and rising rates ahead.
- Flat curve — uncertainty about the path of the economy.
- Inverted curve (short rates above long rates) — historically one of the most reliable recession warnings.
Why bonds rule everything
Government bond yields are the closest thing to a "risk-free rate," and that rate is the benchmark against which all other assets are valued — it's the discount rate behind the DCF you met earlier. When yields rise, stocks, property, and crypto all face a higher bar and tend to fall; when yields drop, risk assets are bid up. For an investor, bonds do two jobs: they provide steady income and ballast in a portfolio, and their signals — the curve, the spreads — tell you what the smartest, largest market in the world thinks is coming.
Key terms
- Coupon — the regular interest a bond pays.
- Yield to maturity — total return if held to maturity, given the price paid.
- Duration — how sensitive a bond's price is to interest-rate changes.
- Credit spread — extra yield a riskier borrower pays over a safe one.
- Yield curve — yields plotted across maturities; a key economic signal.
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