Bonds and fixed income: how bonds work, pay and lose value

A bond is a loan you can buy and sell. A government or a company borrows money from investors and promises, in writing, to pay interest on set dates and to repay the amount borrowed on a set day. Because those payments are fixed in advance, bonds and their relatives (Treasury bills, notes, certificates of deposit, bond funds) are grouped under the name fixed income.

Bonds are the second great asset class after stocks, usually held for income and for stability. Yet between mid-2020 and late 2023 the broad US bond market had its worst decline in modern memory, and long-term Treasury funds lost about half their price. Both facts follow from the same arithmetic.

This guide covers that arithmetic from the beginning: what a bond's payments look like, how its price is worked out, why prices fall when interest rates rise, the main kinds of bonds, the risks each one carries, and what happened to real bond funds when rates jumped.

How a bond works

Every bond is defined by a few terms written into it when it is issued:

• Issuer: the borrower, such as the US Treasury, a city, or a company.
• Face value (Face value (par value)), also called par or principal: the amount repaid at the end, commonly $1,000 for corporate bonds. Treasury securities can be bought in $100 increments.
• Coupon (Coupon): the interest rate on the face value, fixed for most bonds. A 4% coupon on $1,000 is $40 a year.
• Payment schedule: how often the coupon is paid. Treasury notes and bonds pay every six months; many corporate bonds do too.
• Maturity (Maturity): the date the face value is repaid and the bond ends.

The chart shows the whole life of a simple bond. The holder receives nine $40 coupons and then a last payment of $1,040, the final coupon plus the $1,000 principal. If the issuer pays as promised and the holder keeps the bond to maturity, the result is fixed on day one. That certainty is what "fixed income" means.

What is not fixed is the bond's market price between now and maturity. Anyone who wants to sell early has to sell at whatever other investors will pay, and that depends on interest rates in the meantime.

How a bond is priced

A bond's fair price is the present value (Present value) of all the payments it still promises, each discounted at the yield investors currently demand for a bond like it.

This is the single most important fact about bonds: prices and yields move in opposite directions. A rise in market yields lowers the price of every bond already issued, because new bonds now pay more. A fall in yields raises it.

Yield: three numbers people mean

• Coupon rate: the fixed rate printed on the bond, 4% in the example.
• Current yield: annual coupon ÷ current price. At a price of $922.78, it is $40 ÷ $922.78 = 4.33%.
• Yield to maturity (Yield to maturity (YTM)): the single rate that makes the present value of all remaining payments equal the price, here 5%. It counts both the coupons and the $77.22 gain as the price pulls back to par at maturity. It is the number quoted for Treasury yields and the best single measure of what a bond will return if held to maturity and paid in full.

A bond bought at $922.78 and held one year while yields stay at 5% would be worth $928.92, with nine years left. Add the $40 coupon and the one-year return is ($928.92 + $40 − $922.78) ÷ $922.78 = 5.0%, exactly the yield to maturity. The price-yield relationship is explored further in Bond prices and yields: why prices fall when yields rise, and how sensitive a price is to a change in yield is the subject of Bond duration and convexity: measuring interest-rate risk.

The main kinds of fixed income

US Treasuries

The US Treasury borrows through several kinds of marketable securities, according to TreasuryDirect:

Treasuries are backed by the US government and are treated as free of default risk, which makes their yields the benchmark that every other dollar bond is priced against. The full menu is in Treasury bills, notes and bonds: the US government’s debt menu, and inflation-linked TIPS are in TIPS and breakeven inflation: how inflation-protected bonds work.

Corporate bonds

Companies borrow by issuing bonds that pay more than Treasuries of the same maturity, to compensate for the risk that the company cannot pay. That extra yield is the credit spread. On October 28, 2026, Moody's seasoned Aaa corporate yield was 6.02% and its Baa yield 6.48%, against 5.05% for the 10-year Treasury: spreads of about 0.97 and 1.43 percentage points. (Moody's seasoned series hold long-maturity bonds, so the comparison with a 10-year yield is approximate.) Bonds rated below investment grade, often called high yield or junk, pay more again. See Credit ratings and credit spreads: how bond risk is priced and Corporate and high-yield bonds: how company debt behaves.

Municipal bonds

States, cities and public agencies issue municipal bonds, whose interest is generally exempt from federal income tax. Their lower yields have to be compared on an after-tax basis; Municipal bonds: GO vs revenue bonds and tax-free yield math shows how.

Cash-like fixed income

At the very short end, Treasury bills, bank certificates of deposit and money market funds behave like cash. They barely move in price and pay close to current short-term rates. See Money market funds and cash: T-bills, savings and real returns.

Bond funds

Most individuals own bonds through mutual funds or ETFs, which hold hundreds or thousands of issues. A fund never matures: it keeps buying new bonds as old ones expire, so its price does not pull back to par the way a single bond's does. That difference is the subject of Bond ETFs vs individual bonds: maturity, risk and cost compared.

The five risks of owning bonds

FINRA's investor guide lists the risks below. Each kind of bond carries a different mix.

1. Interest-rate risk (Interest-rate risk). When rates rise, prices fall, and the longer the maturity, the larger the fall. This is the dominant risk for Treasuries.
2. Inflation risk. A fixed $40 a year buys less when prices rise. Over a 10- or 30-year life, even moderate inflation takes a large share of the real value. TIPS are designed to remove this risk.
3. Credit or default risk (Credit Risk). The issuer may miss payments or fail to repay. Treasuries are treated as default-free; corporate and high-yield bonds are not.
4. Call risk. Many corporate and municipal bonds let the issuer repay early, usually when rates have fallen, exactly when the holder would rather keep the high coupon.
5. Liquidity risk. Treasuries trade constantly. Many individual corporate and municipal bonds trade rarely, so selling one before maturity can mean a poor price.

The 2020–2023 rate shock on real data

In July 2020 interest rates were near historic lows. The 10-year Treasury yield averaged 0.62% that month, the 30-year 1.31% and the 2-year 0.15%. By October 2023 they averaged 4.80%, 4.95% and 5.07%. The chart shows what that did to three bond funds of different maturities, each rebased to $100 in July 2020:

Three lessons stand out.

Maturity decides the damage. The same rise in rates cut the short fund's price by about 6% and the long fund's by about half. A 2-year bond repays soon, and its holder can reinvest at the new rates; a 25-year bond is locked into its low coupon for decades.

This was not about defaults. The funds in the chart hold Treasuries and high-grade bonds. The loss came purely from rising yields, which is why "safe" and "stable" are not the same thing for bonds.

Higher yields are also the recovery mechanism. After 2023, the funds were collecting far higher interest than in 2020, which a price chart does not show. The 10-year yield averaged 4.99% in September 2026, its highest monthly average since July 2007, and was 5.05% on October 28, 2026. TLT's price made a new monthly-close low in September 2026, about 55% below its July 2020 level, as long-term yields rose again.

For the calendar year 2022, the price falls were 5.1% for SHY, 15.0% for AGG and 32.8% for TLT, while the S&P 500 ETF fell 19.5%: one of the few years when bonds offered no cushion against falling stocks (see Correlation between asset classes: how it works and why it shifts and The 2022 bear market: inflation, Fed hikes and falling bonds).

Bonds in a portfolio

Bonds usually do three jobs:

• Income. Coupons arrive on schedule, which suits spending needs.
• Stability. Short and intermediate bonds swing far less than stocks; AGG's annualized volatility on monthly returns from 2007 to 2026 was about 4.6%, against 15.5% for SPY.
• Diversification. In growth scares and recessions, high-quality bonds have often risen while stocks fell, as in 2008, when TLT's price rose 28.3% and SPY's fell 38.3%. The 2022 experience shows that this depends on the kind of shock.

How much to hold is covered in Asset allocation: how stock, bond and cash mixes have behaved. How the classes compare overall is in Asset classes explained: stocks, bonds, cash, real assets and more. Interest from most bonds is taxed as ordinary income; see How dividends and interest are taxed: qualified, ordinary, muni.

Pitfalls

Confusing a fund with a bond. A single bond held to maturity returns its face value if the issuer pays. A bond fund has no maturity date and can stay below its purchase price indefinitely.

Reaching for yield. A higher yield is payment for more risk: longer maturity, weaker credit, a call feature, or poor liquidity. Ask which one you are being paid for.

Reading a price chart as the return. Bond fund prices exclude coupons. Over long periods, nearly all of a bond fund's return is the interest.

Ignoring inflation. A 4% coupon during 4% inflation earns roughly nothing in real terms. Consumer prices rose 3.7% in the 12 months to September 2026.

Assuming Treasuries cannot lose money. They cannot default in the usual sense, but their prices can fall a long way, as TLT did.

Fixed income compared

How Finabase does it

Finabase does not carry individual bond quotes, credit ratings or bond-level analytics. What it shows is the Treasury market and the funds that hold bonds:

• The Treasury page lists ten Treasury yields, from the 1-month bill to the 30-year bond, with the same 1-week to 2-year change columns as the other market lists. Each opens its own chart, such as the 10-year yield. The CBOE yield indexes are on /indices, for example ^TNX.
• Futures includes Treasury and foreign government bond futures, such as the US 2-, 10- and 30-year contracts and the German Bund.
• Bond ETFs have full symbol pages, such as AGG, TLT, IEF and SHY, with a chart, news and, where the data feed provides it, the fund's holdings.

The cash-flow diagram and the rate-shock chart on this page are ours; the chart uses Finabase's monthly ETF prices, and the yields come from Federal Reserve data.

Frequently asked questions

Why do bond prices fall when interest rates rise?

Because an existing bond's payments are fixed, and buyers can get a higher rate on new bonds. The old bond's price falls until its yield to maturity matches the new market rate. A 10-year 4% bond falls from $1,000 to $922.78 if yields rise to 5%.

Can you lose money in bonds?

Yes. If you sell before maturity after rates have risen, or the issuer defaults, you can lose money. The broad bond fund AGG fell about 23% in price from July 2020 to October 2023, although holders also collected interest throughout.

What is the difference between a bond's coupon and its yield?

The coupon is the fixed interest rate on the face value, set at issue. The yield is the return implied by the bond's current price, which changes every day with the market.

Are bonds safer than stocks?

High-quality bonds have usually swung far less than stocks and have smaller worst-case falls, but they are not risk-free. Long-term Treasuries lost about half their price from 2020 to 2023, and inflation can erode bonds' real value even when prices are stable.

What does it mean when a bond trades above par?

It means its price is above face value, usually because its coupon is higher than the current market yield for similar bonds. The premium shrinks to zero as the bond approaches maturity.

Summary

A bond is a tradable loan with fixed payments: coupons on a schedule and the face value at maturity. Its price is the present value of those payments at the current market yield, so prices fall when yields rise, and longer bonds fall the most. Treasuries, corporates, municipals, TIPS and cash-like instruments differ mainly in credit risk, rate sensitivity and tax treatment. The 2020–2023 rate shock showed the arithmetic at full strength: as yields rose by four to five percentage points, a short Treasury fund lost about 6.5% at worst while a long one lost about half. Bonds remain the income and stability side of most portfolios, but their safety depends on maturity, credit and the kind of economic shock.