Overview

Stocks get all the glory, but the bond market is bigger and smarter. It’s where governments and companies borrow money. It’s “fixed” because you know exactly what you’ll get paid (unless they go bust).

Core Idea

Yield and Price: They move in opposite directions. If interest rates go up, bond prices go down. Why? If I have an old bond paying 2% and new bonds pay 5%, no one wants my old bond unless I sell it at a discount.

Formal Definition (if applicable)

Duration: A measure of the sensitivity of the price of a bond to a change in interest rates. High duration = High risk if rates rise.

Intuition

A bond is an IOU.

  • Principal (Face Value): The amount borrowed ($1,000).
  • Coupon: The interest payment ($50/year).
  • Maturity: When you get your money back (10 years).

Examples

  • Treasuries: US Government bonds (Risk-free).
  • Corporates: Company bonds (Higher yield, higher risk).
  • Junk Bonds: High risk, high reward.

Common Misconceptions

  • “Bonds are safe.” (They are safer than stocks, but you can still lose money if rates rise or the issuer defaults.)
  • “Yield Curve Inversion predicts recessions.” (Usually true. When short-term rates are higher than long-term rates, trouble is coming.)
  • Credit Rating: AAA (Safe) to D (Default). Agencies like Moody’s and S&P rate them.
  • Inflation: The enemy of bonds (because it eats away the fixed payments).
  • TIPS: Treasury Inflation-Protected Securities.

Applications

  • Pension Funds: Need steady income to pay retirees.
  • Central Banks: Buying/selling bonds to control the economy (QE).

Criticism / Limitations

In a low-interest-rate world, bonds offer very little return (“Return-free risk”).

Further Reading

  • Fabozzi, The Handbook of Fixed Income Securities