Lending creates specified payments
An ordinary company bond makes you a creditor; a government can borrow through bonds too. The terms specify what is owed, subject to the borrower paying. A fixed coupon applies to face value, not the purchase price or company profits. Maturity is when principal repayment is due.
Invented bond: €1,000 face value, 4% annual coupon, five years remaining. No early repayment; all payments assumed to arrive as promised.
- End of year 1€40 interestPrincipal still owed
- End of year 2€40 interestPrincipal still owed
- End of year 3€40 interestPrincipal still owed
- End of year 4€40 interestPrincipal still owed
- End of year 5€40 interest+ €1,000 principal returned
€1,040 received
Distinguish face value from purchase price
Face value, or par, is scheduled repayment; market price is what a buyer pays now, possibly above or below it. Buying an existing bond transfers the lender’s claim. Other bonds may pay more frequently, vary interest, pay only at maturity or permit early repayment. Check those terms rather than the coupon alone.
Your purchase price changes the return
Paying below face value can add a gain on repayment; paying above it offsets some coupon income. The contractual maturity amount is face value, not your original purchase price.
Calculate a discounted purchase and interpret its yield
Separate invented bond: pay €950 now for €1,000 principal plus a final €40 coupon in one year. One year remaining; full payment assumed. No other payments, costs or taxes.
Gain: €90 ÷ €950 ≈ 9.47%. The coupon remains 4% of face value; there are no intermediate payments to reinvest.
Yield to maturity expresses scheduled amounts and dates relative to price as an annual rate, assuming payment as scheduled. Default, early sale or repayment, costs, tax and rates for reinvesting coupons can change the realised result. High yield may signal doubt about payment, not extra income without risk.
A creditor supplies capital in exchange for contractual payments. A lower purchase price raises the calculated yield of the same promised payments; if default becomes more likely, the amount actually expected to arrive can fall at the same time.
Fixed payments compete at changing prices
Existing bond pays annually
€40New bond offered at €1,000 pays
€50The older bond’s price generally falls to make its smaller fixed payments competitive. Falling comparable yields generally raise its price instead. Borrower finances can change simultaneously; this explains a mechanism, not the next rate move.
Separate duration from maturity and a price forecast
Otherwise similar longer-dated fixed payments generally have greater interest-rate sensitivity. Even low-default-risk debt can fall sharply when its payments lie far ahead.
Duration measures price sensitivity to yield changes, usually expressed in years, for bonds or bond funds. It is not simply the time until final payment and does not predict yields. The coupon comparison alone cannot give the old bond’s new price: the full payment schedule and required yields determine it.
The borrower still has to pay
Holding to maturity can avoid an earlier sale price. It cannot make the borrower pay, restore purchasing power or move repayment ahead of an earlier bill. Full foreign-currency payments may still fall short of spending needs.
Identify the risks behind a quoted rate
| Risk | What can go wrong |
|---|---|
| Credit risk | Missed payment or deteriorating ability to pay |
| Interest-rate risk | Rising yields reduce the price of fixed payments |
| Inflation risk | Payments buy less |
| Currency risk | Payment currency falls against spending currency |
| Liquidity risk | Poor sale price or no buyer when needed |
| Early-repayment risk | Contractual early return forces reinvestment on different terms |
Credit ratings assess ability to pay, not guarantee it. High-yield debt commonly carries more credit risk than investment-grade debt. Government borrowers also differ in credit quality and currency risk. Check the actual issuer, currency and terms against your spending obligation.
Fund units do not inherit one bond’s repayment date
You own fund units; the fund holds debt and can spread borrowers while handling payments and replacements. Unit value reflects assets and liabilities.
Most ongoing funds set no date to repay your original investment: bonds mature or are sold and replaced under the mandate. Owning units for five years creates no such promise.
Some funds have a planned end date; that design does not guarantee a particular repayment value.
Compare the role of two bond funds
High-quality bonds can supply income and reduce reliance on share returns. Short-term government debt and long-term high-yield corporate debt nevertheless behave differently. A long-dated fund can fall sharply alongside shares. For near spending, examine access, duration, credit quality and currency, rather than rely on “fixed income”.