What is a bond and how does it work?

A bond represents a loan to a borrower (the bond’s issuer) in return for regular interest payments.

Unlike a loan though, once issued (in the so-called primary market), a bond can be re-sold and traded among other investors in the secondary market.

As a retail investor, typically you’ll buy and sell a bond in the secondary market (i.e. after it has been issued) through a broker – this is true for both government and corporate bonds.

Here’s a simple example of how bonds work: if you invest in a $10,000 ten-year bond with a 2% annual yield, what actually happens is you are lending $10,000 to the issuer (be it a government or a corporation) for ten years for $200 annual interest, assuming you hold the bond till maturity.

As bonds tend to have an active secondary market, you can sell your bond at any time before maturity at the prevailing market yield. Proceeds from the sale will of course include any accrued interest.

What else do you need to know about bonds?

Want to learn more before deciding what’s your optimal bond allocation? You might want to check out these other articles to deepen your knowledge.

  • What is a bond?  (our main article in the bond section)
  • What is a bond yield?
  • How do bonds work?
  • What happens when a bond comes due?
  • How to buy bonds?
  • How to invest in bonds?
  • Where to buy bonds?
  • How to buy treasury bonds?
  • What is a government bond?
  • What are convertible bonds?
  • What are junk bonds?
  • What is a secured bond?
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