Bonds: Lending for a Fixed Return

intermediate8 min read

How a bond pays you, why its price moves, and the inverse dance with interest rates.

When you buy a stock, you become an owner. When you buy a bond, you become a lender. A bond is simply an IOU: you lend money to a government or company, they pay you fixed interest (the “coupon”) periodically, and return your principal on a set maturity date.

Because the payments are fixed and contractual, bonds are generally steadier and more predictable than stocks — which is exactly why they’re the “stabiliser” in a portfolio. But there’s one counter-intuitive twist everyone must understand: bond prices move opposite to interest rates.

When market interest rates rise, existing bond prices fall — and vice versa. The logic: your old bond pays a fixed 6%, but if new bonds now pay 8%, no one will buy yours at full price — its price must drop until its effective yield matches the new 8%. The bond’s cash flows are frozen, so the only thing that can adjust is its price. That inverse seesaw is the single most important idea in fixed income.

ExampleYou hold a ₹1,000 bond paying 6% (₹60/yr). Rates jump and new bonds pay 8%. To sell yours, you must discount it — roughly toward ₹750, where ₹60 a year is about an 8% yield. Same coupon, lower price. If rates had fallen to 4%, your 6% bond would instead trade at a premium.

Key takeawayA bond is a loan that pays fixed interest and returns principal at maturity — steadier than stocks. Crucially, bond prices move inversely to interest rates: rates up, prices down; rates down, prices up.

FAQs

If I just hold a bond to maturity, do price swings matter?

Less so — if the issuer doesn’t default, you get your fixed coupons and full principal back at maturity regardless of interim price moves. Price swings matter most if you might sell early, or if you hold bond *funds* (whose NAV reflects market prices daily).