Bonds and Treasuries: lending money, with a price that moves

When you buy a bond, you are the lender. A government or a company borrows your money, promises to pay you interest on a schedule, and promises to hand the money back on a set date. That part is simple. The part that trips people is that the promise can be sold to someone else before that date, and its price goes the opposite way from interest rates. Let me show you why.

The words

Face value, or par, is what you get back at the end, usually $1,000. The coupon is the yearly interest, as a percent of that. Maturity is the date the money comes back. Yield to maturity is what you would actually earn if you bought at today's price and held to the end, counting the interest and the difference between what you paid and the $1,000.

Why the price moves the opposite way from rates

Say you own a ten year bond paying 3 percent. Tomorrow, new ten year bonds come out paying 5 percent. Nobody will pay you full price for a 3 percent promise when a 5 percent promise is sitting right there. So your bond's price drops until whoever buys it ends up earning about 5 percent anyway. If rates instead fall to 2 percent, your 3 percent bond suddenly looks great and its price rises. The coupon never changed. The price did.

Treasuries, specifically

US Treasury securities are backed by the federal government. Bills mature within a year and are sold at a discount rather than paying coupons. Notes run two to ten years. Bonds run twenty to thirty. TIPS adjust their principal for inflation. I bonds and EE bonds are savings bonds with their own rules and cannot be traded. Interest on Treasuries skips state and local income tax but not federal. You can buy them at auction through TreasuryDirect, through a broker, or inside a fund.

The risk that the borrower does not pay

Corporate and municipal bonds carry the risk that the borrower cannot pay you back. Rating agencies grade this, from investment grade down to high yield, which people call junk. Higher interest on a lower rated bond is payment for taking that risk, not a gift. A fund with "income" in its name may hold a lot of it.

Where the tidy version goes wrong

"Bonds are safe" is true of a Treasury's promise to pay and false of a long bond fund's price in a year when rates jump. "Bonds are boring" was true for long stretches and false in 2022. The word covers everything from a three month bill to a thirty year junk bond, and that range is the point.

Questions worth asking yourself

What is the duration of what you hold? Who is the borrower, and what is their rating? Are you holding individual bonds to the end, or a fund with no end date? What is the yield to maturity, not just the coupon? And how is the interest taxed where you live?