Price and Yield Move in Opposite Directions
A bond promises fixed payments. If market rates rise, those fixed payments become less attractive, so the price must fall until the bond yields what new bonds yield. This inverse relationship is the single most important fact about bonds:
Price = Σ Coupon / (1 + y)t + Face value / (1 + y)n
The price is simply the present value of every payment the bond will make, discounted at the market yield.
Bond Price Chart
Price of a $1,000 bond with a 4.5% coupon, semiannual payments:
| Market yield | 2 years | 5 years | 10 years | 20 years | 30 years |
|---|---|---|---|---|---|
| 3% | $1,028.91 | $1,069.17 | $1,128.76 | $1,224.37 | $1,295.35 |
| 4.5% | $1,000.00 | $1,000.00 | $1,000.00 | $1,000.00 | $1,000.00 |
| 6% | $972.12 | $936.02 | $888.42 | $826.64 | $792.43 |
| 8% | $936.48 | $858.06 | $762.17 | $653.63 | $604.09 |
Read across any row: the longer the maturity, the more the price moves for the same change in yield. That sensitivity is duration, and it is why a 30-year Treasury can lose more value in a rate shock than a stock index.
Three Yields, Three Meanings
- Coupon rate — the fixed percentage of face value paid each year. It never changes.
- Current yield — annual coupon divided by market price. Ignores any gain or loss at maturity.
- Yield to maturity — the total annualized return if held to maturity, including the pull toward par. This is the figure to compare bonds with.
For a bond bought at a discount, YTM exceeds the current yield, which exceeds the coupon rate. At a premium the order reverses.
Premium and Discount
A bond trades above par when its coupon beats current market rates, and below par when it lags. The price converges to face value as maturity approaches, regardless of what happens to rates in between — a phenomenon known as the pull to par. Holding to maturity therefore eliminates price risk, though not the opportunity cost of being locked into a below-market rate.
The Risks That Remain
Interest rate risk is the price sensitivity above. Credit risk is the issuer failing to pay — absent for Treasuries, real for corporates, priced into the yield spread. Inflation risk erodes fixed payments; TIPS address this by indexing principal. Call risk applies when the issuer can redeem early, which they do precisely when rates fall and you would rather keep the bond.
Frequently Asked Questions
Why did my bond fund lose money?
Because rates rose. Bond funds hold bonds priced daily, so a rate increase shows up immediately as a loss even though the underlying bonds will still pay in full at maturity.
What is duration in plain terms?
Approximately the percentage a bond's price falls for a 1% rise in yield. A duration of 8 means roughly an 8% loss on a 1% rate rise.
Are bonds safer than stocks?
Less volatile, generally, but not risk-free. In 2022 long-dated Treasuries fell more than 30% — a reminder that safety from default is not safety from price movement.