Bonds: Being the Lender

Stocks make you an owner. Bonds make you a lender. Owners get whatever's left after everyone's paid; lenders get paid first, but never get more than they were promised.

Last verified 2026-07-16

A loan with a printed schedule

Buy a bond and you have lent money on fixed terms. Face value is what comes back at the end, conventionally $1,000. The coupon is the interest, a fixed percentage of face value. Maturity is the date the loan ends. All three are set at issue and never change.

That last point is the whole lesson. Say you hold a 10-year bond with a 3% coupon — $30 a year on $1,000 — and market rates rise to 6%. New bonds now pay $60. Nobody will pay you $1,000 for $30 a year when $60 is available at the same price.

Your coupon cannot rise to meet the competition, so price is the only thing left to move. It falls until the $30 payments and the eventual $1,000 repayment add up to 6% for a new buyer — around $779. Nobody did anything wrong and no payment was missed. The bond simply repriced.

Coupon is what it pays. Yield is what you get.

Because price moves and the coupon doesn't, the two stop matching the moment a bond trades away from face value — and the word for what you actually earn is yield.

The simplest version is current yield: the annual coupon divided by the price you paid. A $1,000 bond with a $50 coupon yields 5% if you paid $1,000, but 6.25% if you picked it up for $800. Same bond, same $50 a year, different deal — because you paid less for the identical stream of payments.

A quoted 'yield to maturity' goes further and folds in the gain or loss you'll realise when the face value is repaid at the end. Either way, the rule holds: when someone quotes a bond's rate, ask whether they mean what it pays or what you get.

Who you lent to, and where you stand in line

Rates are one risk. The other is that the borrower doesn't pay, and that risk is priced. US Treasuries are backed by the full faith and credit of the US government, so they pay least. Investment-grade corporates pay more; high-yield 'junk' bonds pay considerably more and default meaningfully more often. Yield is compensation, and a bond paying well above the benchmark is telling you why.

If the borrower does fail, position in the queue decides everything. Debt sits ahead of equity: bondholders are paid before shareholders see anything, and in most bankruptcies that leaves shareholders with nothing at all.

That is the trade. Bondholders accept a capped return for being first in line; shareholders take last place for unlimited upside. Neither is safer in the abstract — they are different deals, and a portfolio usually wants both.