A bond is a debt security: its issuer promises payments under specified terms. Investors encounter several related figures, including the bond's price, coupon, yield and maturity. They describe different things. Understanding the difference helps explain why an existing bond can lose market value even while the issuer continues to pay its stated coupon.
This U.S.-focused guide describes general concepts, not a forecast or a recommendation. Bonds differ in credit quality, tax treatment and contractual features. Read the particular offering documents and pricing information before relying on a general example.
Coupon, price and yield
A fixed coupon is the interest payment specified by the bond's terms, usually expressed as a percentage of face value. Face value is generally the amount due at maturity, subject to the issuer meeting its obligations and the bond's terms. Market price is what buyers and sellers agree to pay for the bond now; it can be above or below face value.
Yield relates the income or expected return to the price paid. Current yield divides annual coupon income by the current price, but it does not capture every component of return. Yield to maturity is a broader calculation based on the purchase price and promised payments through maturity, using assumptions including timely payment and reinvestment. A callable bond may be repaid early, so yield to call and other measures can also matter.
Why prices respond to rates
When comparable newly issued bonds offer higher yields, an older fixed-coupon bond generally becomes less attractive at its former price. Its price tends to fall until its yield is more competitive. The reverse generally occurs when comparable yields fall. Changes in an issuer's credit quality, liquidity or market conditions can also affect price, so the relationship is not a complete explanation of every price movement.
Imagine a fixed-rate bond purchased at face value. If market yields later rise, a sale before maturity could bring less than the purchase price. If the investor holds the individual bond to maturity and the issuer makes all promised payments, its face value is generally repaid under its terms. That does not erase inflation, opportunity cost, default risk or possible early redemption.
Duration as an estimate
Duration measures sensitivity to interest-rate changes, expressed in years. It is not simply the number of years until maturity. A bond or fund with higher duration generally experiences a larger percentage price change for a given yield change, all else equal. FINRA describes duration as a useful way to understand this sensitivity.
For an illustrative approximation, a duration of five suggests a roughly 5% price decline for a one-percentage-point increase in relevant yields, or a roughly 5% increase for an equivalent decline. This is a simplified estimate, not a guaranteed result. It is most useful for small changes and assumes other influences remain constant. The actual relationship is curved, and different rates can move by different amounts.
Individual bonds and bond funds
An individual bond has contractual maturity and payments, whereas a bond fund holds a changing portfolio and its shares do not generally mature like an individual bond. A fund's duration and holdings can change as the manager trades or bonds age. Income distributions may change, and fund shares can be sold for more or less than their purchase price.
A bond ETF also trades at a market price that can differ from its net asset value. Its price, fund expenses and trading spread belong in the comparison. The yield shown in a quotation or fact sheet may use different conventions; check its label and calculation date before comparing it with another number.
Questions for the next document
- Is the issuer able to meet its obligations, and what happens if it does not?
- Is the rate fixed or floating, and can the bond be called before maturity?
- Which yield is quoted, and does the calculation include the purchase price and fees?
- What duration measure is shown, and how recently was it calculated?
- Will the money be needed before maturity, requiring a sale at an uncertain price?
Lower duration does not mean no risk. Credit losses, inflation, liquidity and call features can matter even when rate sensitivity is modest. The appropriate interpretation depends on the instrument and the investor's purpose, rather than on a single statistic.
Price quotations may exclude accrued interest, which can affect the amount paid at settlement. Ask the broker how its quotation, markup or commission and accrued interest combine in the transaction. Compare alternatives using the same yield convention and settlement assumptions, and remember that a quoted market price can change before a trade is completed.