# How Bonds Work > A bond is a loan that pays interest and returns principal at maturity. Learn coupons, price and yield, why prices fall when rates rise and the main bond risks. Source: https://learn.tradelabsai.com/bonds-credit/how-bonds-work/ Track: Bonds, Rates and Credit · Level: Intermediate · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "How Bonds Work", https://learn.tradelabsai.com/bonds-credit/how-bonds-work/ A bond is a loan. When you buy a bond, you lend money to an issuer, such as a government or company, which promises to pay interest (coupons) at set intervals and repay the face value (principal) on a set date (maturity). Bonds are the backbone of global finance: the bond market is larger than the stock market by many measures, and bond yields set the cost of borrowing for governments, companies and homeowners. The short introduction is in [What Is a Bond?](https://learn.tradelabsai.com/markets/what-is-a-bond/); this lesson explains how bonds are priced and why their prices move. ## The parts of a bond | Term | Meaning | |---|---| | Face (par) value | Amount repaid at maturity, often $1,000 or $100 per unit | | Coupon rate | Annual interest as a percentage of face value | | Coupon frequency | How often coupons are paid; semiannual is common in the US | | Maturity date | When principal is repaid | | Issuer | The borrower: government, agency, company, municipality | | Price | What the bond trades for, quoted as a percentage of par | | Yield | The return implied by the price. See [Yield to Maturity](https://learn.tradelabsai.com/bonds-credit/yield-to-maturity/) | ## Price and yield move in opposite directions A bond's coupons are fixed. If market interest rates rise, new bonds pay more, so existing bonds with lower coupons must fall in price to offer a competitive yield. If rates fall, existing bonds become more valuable. **Example: Why prices fall when rates rise** A 10 year bond with a 4% coupon pays $40 a year on $1,000 face value. When issued, market yields are 4%, so it trades at par ($1,000). A year later, yields on similar bonds rise to 5%. A new buyer can get 5% elsewhere, so they will only buy the 4% bond at a discount. With 9 years left, its price falls to about $928, at which its yield to maturity is 5%. If yields had instead fallen to 3%, its price would rise to about $1,078. ## Bond pricing A bond's price is the present value of its future cash flows, discounted at the market yield: ``` price = Σ coupon / (1 + y)^t + face value / (1 + y)^n ``` where y is the yield per period and n is the number of periods. See [Time Value of Money](https://learn.tradelabsai.com/math/time-value-of-money/) and try the [Bond Price, Duration and DV01 Calculator](https://learn.tradelabsai.com/tools/bond-calculator/). ## Premium, par and discount | Bond trades at | When | Price vs face | |---|---|---| | Premium | Coupon rate above market yield | Above par | | Par | Coupon rate equals market yield | At par | | Discount | Coupon rate below market yield | Below par | Zero coupon bonds pay no coupons and are always issued at a discount, paying face value at maturity. ## Clean and dirty prices Bonds accrue interest between coupon dates. Quoted prices are usually "clean" (excluding accrued interest); the amount actually paid is the "dirty" or full price, clean price plus accrued interest. ## Main types of bonds | Type | Issuer | Lesson | |---|---|---| | Government bonds | National governments | [Treasury Bills, Notes and Bonds](https://learn.tradelabsai.com/bonds-credit/treasury-bills-notes-and-bonds/) | | Corporate bonds | Companies | [Corporate Bonds](https://learn.tradelabsai.com/bonds-credit/corporate-bonds/) | | Municipal bonds | States and cities | [Municipal Bonds](https://learn.tradelabsai.com/bonds-credit/municipal-bonds/) | | High yield bonds | Lower rated companies | [Investment Grade vs High-Yield Bonds](https://learn.tradelabsai.com/bonds-credit/high-yield-bonds/) | | Inflation linked bonds | Governments (e.g. TIPS) | Principal adjusts with inflation | | Securitised bonds | Pools of loans | [CLOs](https://learn.tradelabsai.com/bonds-credit/clos/) | ## Bond risks - **Interest rate risk:** prices fall when yields rise. Longer bonds are more sensitive. See [Duration](https://learn.tradelabsai.com/bonds-credit/duration/). - **Credit risk:** the issuer may default. See [Credit Ratings](https://learn.tradelabsai.com/bonds-credit/credit-ratings/) and [Default Probability and Recovery Rate](https://learn.tradelabsai.com/bonds-credit/default-probability/). - **Inflation risk:** rising inflation erodes fixed coupons. See [Inflation](https://learn.tradelabsai.com/macro/inflation/). - **Liquidity risk:** some bonds trade rarely and at wide spreads. - **Call risk:** issuers may repay early when rates fall. - **Reinvestment risk:** coupons may be reinvested at lower rates. In 2022, as inflation surged and central banks raised rates quickly, broad US bond indices suffered their worst year in decades, with losses of around 13%, a reminder that bonds are not risk free. ## How bonds trade Most bonds trade over the counter through dealers rather than on exchanges. US Treasuries are among the most liquid securities in the world; many corporate and municipal bonds trade infrequently. Individuals often access bonds through funds and ETFs. See [OTC Markets](https://learn.tradelabsai.com/market-structure/otc-markets/) and [Bond Trading](https://learn.tradelabsai.com/markets/bond-trading/). ## Frequently asked questions ### How do bonds work? A bond is a loan to an issuer that pays periodic interest and repays the face value at maturity. Its price changes as market interest rates and credit risk change. ### Why do bond prices fall when interest rates rise? Because existing bonds pay fixed coupons; when new bonds offer higher yields, older bonds must fall in price to offer a competitive return. ### Are bonds safe? High quality government bonds have low default risk but can lose value when rates rise. Lower rated bonds carry significant credit risk. Next, learn about the most important bond market in [Treasury Bills, Notes and Bonds](https://learn.tradelabsai.com/bonds-credit/treasury-bills-notes-and-bonds/). ## Continue learning - Next lesson: [Treasury Bills, Notes and Bonds](https://learn.tradelabsai.com/bonds-credit/treasury-bills-notes-and-bonds/) - Related: [What Is a Bond?](https://learn.tradelabsai.com/markets/what-is-a-bond/): A bond is a loan you make to a government or company in return for interest. Learn coupons, face value, yield, why bond prices fall when rates rise and the risks. - Related: [Yield to Maturity](https://learn.tradelabsai.com/bonds-credit/yield-to-maturity/): Yield to maturity is the total return of a bond held to maturity. Learn how YTM is calculated, current yield, yield to call and worst, and YTM's assumptions. - Related: [Duration](https://learn.tradelabsai.com/bonds-credit/duration/): Duration measures how sensitive a bond's price is to interest rate changes. Learn Macaulay, modified and effective duration, how to calculate them and their uses. - Related: [Credit Ratings](https://learn.tradelabsai.com/bonds-credit/credit-ratings/): Credit ratings from S&P, Moody's and Fitch grade the risk of default on bonds. Learn the scales, investment grade vs high yield, default rates by rating and limits. - Related: [Treasury Bills, Notes and Bonds](https://learn.tradelabsai.com/bonds-credit/treasury-bills-notes-and-bonds/): US Treasuries are bills, notes and bonds issued by the federal government. Learn their maturities, how auctions work, TIPS, how they trade and why they matter. - Related: [Bond Price, Duration and DV01 Calculator](https://learn.tradelabsai.com/tools/bond-calculator/): Free bond calculator. Enter face value, coupon, yield to maturity, years and payment frequency to get the bond price, current yield, duration and DV01.