A bond is a loan you make to a government, municipality, or corporation. In exchange for the money you hand over, the borrower promises to pay you interest on a set schedule and return your original investment on a specific future date. That is what a bond means in plain terms, and it is why bonds sit at the center of most retirement accounts, pension funds, and any portfolio built around steady income rather than share-price growth.
The Terms That Define Every Bond
Four features shape what you earn and when you get paid.
Face value, sometimes called par value, is the amount the borrower pays back at maturity. Most bonds are issued at $1,000 face value, and every other calculation runs off that number.
The coupon rate is the annual interest, expressed as a percentage of face value. A 5% coupon on a $1,000 bond pays $50 a year, usually split into two $25 payments six months apart.
The maturity date is when the issuer returns your principal. Maturities range from a few weeks to 30 years depending on the bond. Once the issuer pays you the face value on that date, the arrangement is finished.
Yield to maturity is the fuller measure of return. It folds in the coupon payments, the face value you receive at the end, and the gap between what you paid and that face value. Buy a bond below par and the yield to maturity comes in higher than the coupon rate, because you eventually pocket the price difference. Pay above par and the yield to maturity is lower than the coupon.
How a Bond Differs From a Stock
A stock makes you a partial owner of a company. A bond makes you a lender. Bondholders do not vote on company decisions and do not share in profits when the business does well. What they get instead is a contractual right to fixed interest payments and repayment of principal, and that contract carries legal weight.1Investor.gov. Bonds
The trade-off is priority. If the company goes bankrupt, bondholders sit ahead of stockholders in the line to recover money from what is left. Stockholders often end up with nothing in a liquidation, while bondholders frequently recover at least a portion of what they put in.
The Main Types of Bonds
Treasury Securities
The U.S. federal government issues Treasury securities to fund its operations. They come in three forms based on how long they take to mature: Treasury bills run from 4 weeks to 52 weeks, Treasury notes mature in 2 to 10 years, and Treasury bonds mature in 20 or 30 years.2TreasuryDirect. About Treasury Marketable Securities Because they are backed by the full faith and credit of the U.S. government, Treasuries are widely considered among the safest investments available, and investors tend to move into them during stock-market turbulence.
Treasury Inflation-Protected Securities, or TIPS, are a specialized version. The principal adjusts up or down with the Consumer Price Index. When inflation rises, the principal grows, and because interest is calculated on the adjusted principal, the interest payments grow too. At maturity you receive whichever is greater, the inflation-adjusted principal or the original face value, so you are also protected against deflation.3TreasuryDirect. Treasury Inflation-Protected Securities (TIPS)
Municipal Bonds
State and local governments issue municipal bonds to fund schools, highways, water systems, and other public projects. The draw is the tax break: interest on most municipal bonds is excluded from federal income tax.4Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds That exclusion is worth more the higher your tax bracket. For someone in the 35% or 37% federal bracket, which for 2026 kicks in at $256,225 and $640,600 of taxable income for single filers, a 4% municipal bond delivers the same after-tax income as a taxable bond paying considerably more.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Corporate Bonds
Companies issue bonds to finance research, acquisitions, equipment, or day-to-day operations. Corporate bonds must be registered with the SEC under the Securities Act of 1933, which requires detailed disclosures about the company’s business, financial condition, management, and the terms of the bond.6U.S. Government Publishing Office. Securities Act of 1933 They generally pay higher interest than Treasuries or municipals because they carry more risk. The issuer might hit financial trouble, miss payments, or go bankrupt, and the extra yield is compensation for that uncertainty.
Zero-Coupon Bonds
Some bonds pay no periodic interest. You buy them at a steep discount and receive the full face value at maturity. A zero-coupon bond with a $1,000 face value and a 20-year maturity might sell for $500 today; your profit is the $500 gap earned over those two decades.
The catch is taxes. Even though no cash arrives until maturity, the IRS treats the annual increase in the bond’s value as taxable income each year. The agency calls this original issue discount, and you owe tax on it annually whether or not you have seen a dime.7Internal Revenue Service. Publication 1212 – Guide to Original Issue Discount (OID) Instruments For that reason, zero-coupon bonds work best inside tax-advantaged accounts like IRAs.
Credit Ratings and Bond Quality
Before you buy, it helps to know how likely the issuer is to actually pay you back. That is what credit ratings measure. Agencies like Moody’s, Standard & Poor’s, and Fitch grade bond issuers based on their financial strength and likelihood of default.8Securities and Exchange Commission. The ABCs of Credit Ratings
The line that matters most is the split between investment grade and non-investment grade. Bonds rated BBB- or higher by Standard & Poor’s, or Baa3 and above from Moody’s, count as investment grade. These issuers have stable finances and a low probability of missing payments, and their yields are lower to match.8Securities and Exchange Commission. The ABCs of Credit Ratings
Bonds below that threshold are called high-yield or “junk” bonds. The higher rates exist for a reason: the issuer’s finances are shakier, and the chance of default is meaningfully larger. For individual investors, high-yield bonds can boost income but require a stronger stomach for volatility.
What Can Go Wrong
Credit quality gets most of the attention, but a few other risks catch new bond investors off guard.
- Interest rate risk. Bond prices and market rates move in opposite directions. The SEC’s own example: a $1,000 bond with a 3% coupon and 10 years to maturity would drop to roughly $925 if market rates rose by one percentage point. Longer-term bonds swing more than shorter-term ones.9Securities and Exchange Commission. Interest Rate Risk – When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall
- Inflation risk. Because most bonds pay a fixed dollar amount, rising prices erode what that money can actually buy. A $50 payment feels a lot less generous when inflation is running at 4%.
- Call risk. Some bonds let the issuer pay them off early, usually when rates fall. You get your principal back, but you have to reinvest at the lower rates that prompted the call in the first place.1Investor.gov. Bonds
- Liquidity risk. Not every bond trades actively. Treasury securities are highly liquid; a small municipal issue from a rural county may not be, and selling quickly can mean accepting a lower price.
Why Bond Prices Move After Issuance
Once issued, a bond does not just sit until maturity. It trades among investors on the secondary market, and its price moves with interest rates.
The intuition is straightforward. If you own a bond paying 3% and new bonds start paying 4%, nobody will pay full price for yours; they would rather buy the new one. So the price drops until the effective yield for a new buyer roughly matches what is available elsewhere. The same $1,000 bond in the SEC’s example would rise to about $1,082 if market rates fell by one percentage point instead.9Securities and Exchange Commission. Interest Rate Risk – When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall
This only matters if you sell before maturity. Hold the bond to the end and you get the full face value back regardless of what happened to its market price along the way, assuming the issuer does not default.1Investor.gov. Bonds
How Bond Income Is Taxed
Tax treatment depends on who issued the bond and how long you held it.
Corporate bond interest is taxed as ordinary income at both the federal and state level, which for 2026 puts it in the 10% to 37% range depending on your bracket.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Treasury bond interest is taxable federally but exempt from state and local income taxes. Municipal bond interest is generally exempt from federal income tax, and often from state tax if you live in the issuing state.4Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds
Sell a bond on the secondary market for more than you paid and the profit is a capital gain. Bonds held for more than a year qualify for long-term capital gains rates. Bonds held a year or less are taxed at your regular income rate. Zero-coupon bonds create an annual tax obligation on income you have not actually received, which is why they generally belong in tax-sheltered accounts.7Internal Revenue Service. Publication 1212 – Guide to Original Issue Discount (OID) Instruments
Individual Bonds Versus Bond Funds
You can invest in bonds two ways: buy individual bonds directly, or buy shares in a mutual fund or exchange-traded fund that holds a portfolio of them.
The biggest practical difference shows up at maturity. Hold an individual bond to the end and you get its face value back, assuming no default. That predictability is the main appeal. A bond fund has no maturity date. It holds dozens or hundreds of bonds maturing at different times, and its share price rises and falls daily with interest rates and the value of the underlying holdings. You could sell fund shares for more or less than you paid.
Bond funds offer diversification that is hard to build on your own. Individual corporate or municipal bonds often require minimum purchases of $5,000 or more, which makes a diversified personal portfolio expensive. Funds spread that risk across many issuers at a much lower entry point. The trade-off is the expense ratio, which for low-cost bond ETFs runs below 0.2% and for bond mutual funds typically stays under 0.4%.
How to Buy Bonds
Treasury securities are the easiest to buy directly. TreasuryDirect.gov lets individuals purchase Treasury bills, notes, bonds, and TIPS through an online account with a minimum of $100.2TreasuryDirect. About Treasury Marketable Securities You participate in the same auctions as institutional investors, with no fees or commissions.
Corporate and municipal bonds typically require a brokerage account. Most major brokerages run bond-trading platforms where you can search by issuer, maturity, credit rating, and yield. New issues are sometimes available through your broker at face value; secondary-market bonds trade above or below par depending on current rates. Bond funds and bond ETFs trade through the same brokerage account you would use for stocks, which is the simplest way in for anyone who wants fixed-income exposure without researching individual issuers.