What Is a Bond?

Buying a bond = lending money

You lend the face value and get a bond in return: an IOU that spells out the interest and repayment date.

Interest every year, principal at maturity

Each year you receive a coupon at the coupon rate; at maturity, the last coupon comes back together with the principal.

Zero-coupon bonds: discount first, principal later

A zero-coupon bond pays no interest at all along the way; instead it's sold to you at a discount. At 5%, $1,000 in 10 years is worth only about $614 today, and the extra you get back at maturity is the interest.

Key takeaways

• Face value: the principal repaid at maturity, often $1,000.
• Coupon: the interest paid regularly at the coupon rate. Coupon = face value × coupon rate.
• Maturity: the day the principal is repaid. Hold to maturity with no default and the cash flows are certain.
• A zero-coupon bond pays no interest along the way; you profit by buying below face value and getting face value back at maturity.

Try it yourself

You can do these exercises in this lesson's interactive simulation:

1. Click “Example: 5% · 3 years” and play: how much coupon do you receive each year? How much in total by maturity?
2. Set the coupon rate to 8% and the maturity to 5 years: what are the “Coupon per year” and “Total received to maturity”?
3. Drag the term to 10 years: what does the total interest become? Why is the last green bar so tall?
4. Switch between “Government / Company”: the cash flows are exactly the same, so what's really different?

Quiz and explanations

1. A bond has a $1,000 face value and a 5% coupon rate, paid annually. How much interest do you get each year?

Answer: $50.$1,000 × 5% = $50.

2. You hold a 3-year bond to maturity ($1,000 face value, 5% coupon, no default). How much do you receive in total?

Answer: $1,150.3 coupons totaling $150 + $1,000 principal.

3. A 1-year zero-coupon bond has a $1,000 face value and costs $952 today. Roughly what's your return if you hold it to maturity?

Answer: 5.0%.You get $48 more at maturity, and $48 ÷ $952 ≈ 5.0%. A zero-coupon bond's entire return comes from the price difference.

Terms in this lesson

• bond (Bond): An IOU: the issuer borrows your money, pays you interest regularly and repays the principal at maturity.
• coupon (Coupon): The interest paid regularly to bondholders based on the coupon rate.
• coupon rate (Coupon Rate): The coupon as a percentage of face value, set at issue and usually fixed.
• face value (Face Value): The principal a bond repays at maturity, commonly $1,000.
• maturity (Maturity): The date the issuer repays the principal.
• zero-coupon bond (Zero-Coupon Bond): A bond that pays no coupons, issued below face value and repaid at face value at maturity; the gap between the two is your entire return.