Suppose you lend $200 to the US government for five years. You are promised $4 every six months, plus the $200 back at the end. You could put those payments on a calendar before handing over the money.
There is one number the calendar cannot tell you: what you could sell the loan for before those five years are up. A borrower can promise fixed payments without anyone promising you a fixed resale price.
A loan with stated terms
A bond is an IOU that investors can buy and sell. The borrower is the issuer; you are the bondholder. With shares in Harbor Coffee, our fictional coffee business, you own part of the company. A bond makes you a lender.
Face value is the amount the borrower promises to repay. It is also called principal or par value. Interest payments are called coupons.
For this example, suppose you pay $200 for a new note with these terms:
| Term | Example | Meaning |
|---|---|---|
| Face value | $200 | Principal due back |
| Coupon rate | Fixed 4% a year | Annual rate on face value |
| Frequency | Twice yearly | When coupons arrive |
| Maturity | In 5 years | Date principal is due |
The five-year US loan is formally a Treasury note. We use bond for the broader lending idea.
Face value belongs to the promise. Price is what a buyer pays for it. The two match in this example, but they can differ.
Follow the $200
Four percent applies to a full year: $200 × 0.04 = $8 of annual interest.
$200 × 0.04 ÷ 2 = $4 every six months. Paying twice a year splits the $8; it does not double it.
Assume you receive every payment through maturity and keep the coupons as cash, with no fees or taxes.
Each $4 pays you for lending the money. It does not chip away at the debt: after the first coupon, the Treasury still owes $200 of principal. The same is true after the ninth coupon.
That is why the timeline's final payment is so much larger. Most of it is your own money coming home.
Five years × two coupons a year = ten coupons. Ten × $4 = $40 of interest over the whole five years.
Add the returned $200 and your total receipts are $240. Only $40 is income; the other $200 replaces what you lent.
Who has to make the payments
The US Treasury borrows for the federal government. State and local governments issue bonds too, as do companies. The schedule tells you what is owed; the issuer tells you whose promise you are relying on.
For a company, bond interest is a bill to pay. It owes its agreed bond payments even when it pays shareholders no dividend. With a plain fixed-rate bond, a boom in profits does not entitle you to bigger coupons either.
That obligation makes a financially strong company's bond payments easier to plan around than its future dividends. But a schedule cannot tell you whether the company will have the money to pay. Its ability to repay matters too.
Failure to make a promised payment is called default. Bondholders have the creditor's place ahead of common owners when a failed US company's assets are sold, but they can still lose money.
The payments and the price can differ
Suppose you need the $200 in year two. Maturity does not move forward just because your plans change. To get the money out, you may have to sell the note to another investor at the price available then.
Selling passes the remaining payment schedule to the buyer. It does not start a new five-year loan. The note keeps its original maturity date and its $4 coupons; the sale price is what can change.
If new loans of similar risk and remaining length offer more interest on $200, your fixed $4 payments become less attractive. A lower price helps your note compete. When market rates fall, the reverse can happen. This is why bond prices and yields move in opposite directions.
Doubts about repayment can also push a bond's price down.
At maturity, the principal due on this note is still $200. Buying it for a different price does not change that amount. The last $4 coupon is due alongside it.
Waiting until maturity removes the need to find a buyer. You still rely on the issuer to pay, and those fixed dollars can buy less as prices rise.
A bond fund, which pools investors' money to own bonds, does not promise to return your purchase amount on this note's repayment date.
Of the final $204, how much is income? Just $4; the other $200 is returned principal.
For an early sale, the missing number is the price. For a loan held to maturity, the question becomes what the payments will buy. Inflation and real returns takes up that question next.
In short
- A bond makes you a lender, with payments defined by its terms.
- The coupon rate applies to face value, even when the bond trades at a different price.
- Only $4 of this note's final $204 payment is interest income.
- Fixed payments do not fix the price available before maturity.
- The borrower can fail to pay, and inflation can reduce what repayment buys.