Bonds made simple: A beginner's guide to fixed income
Reading time: 20 minutes
The bond market – sometimes referred to as the ‘credit market’ – has a total global debt outstanding of nearly US$160 trillion as of August 2025, according to the Bank for International Settlements. While that figure eclipses the global stock market, equities tend to claim the spotlight in financial media. For many investors, bonds (or ‘fixed income’) remain the quiet engine running in the background that helps power many investment portfolios.
Bonds defined
The most common way to describe a bond is that they are a loan – a well-structured IOU. We all understand the logic behind a loan, typically involving a bank lending money to you, the borrower. However, with bonds, instead of you owing money to a lender, you are the lender. You hand over your cash to governments or companies looking to raise money, who, in return, compensate you with periodic interest payments and the promise to return your initial investment.
Suppose you buy a US government bond priced at US$1,000, with a 3% annual interest payment and a 5-year life cycle. Assuming you hold the bond for five years, you will receive 30 USD each year, in addition to your original 1,000 USD returned.
So, when a company or government (the bond issuer) wants to raise money, it generally has two options: issuing equity or raising debt. With equity, the company sells shares to investors. In return, investors receive a share of ownership – this makes you a shareholder who now participates in profits and losses, and any dividends that are paid out. Conversely, bonds do not involve ownership – the company borrows money from investors and agrees to repay the initial amount borrowed on a set date, along with periodic interest.
In the bond market, a number of different types of investment options exist, from the basic government bonds to corporate bonds, municipal bonds, high-yield bonds (also called ‘junk’ bonds), as well as green bonds (these are a relatively new addition to the fixed-income space, which are issued to specifically fund environmentally friendly projects). The distinction between investment-grade and junk is one I feel is worth highlighting here. It is determined by the three major credit rating agencies – Moody's, S&P, and Fitch. Anything rated BBB- or above is considered investment grade; below that, you are in high-yield territory. Importantly, this applies to all bond types.
Getting to know the language of bonds
Like any field, the financial markets have their own ‘language’ – specific terms and phrases that can confuse new market participants. Frankly, I feel it is unnecessarily complicated, so hopefully this will help decode some of the most common terms.
Maturity:
Maturity is a specific date at which the issuer must repay the initial investment. You can think of this as the loan's expiration date.
Bond maturities vary from being very short-term (under 1 year) to long-term (10 years or more). As you would expect, to lock in your money for longer periods, you are generally compensated with a higher return. In financial parlance, this is referred to as ‘term premium’, used to measure duration risk.
Principal:
Bond investors often talk about the ‘principal’ – it can also be referred to as ‘face value’ or ‘par value’. This is the amount of money you will be repaid at maturity. It is vital to understand that this can be (and often is) different from the price you paid when you bought the bond.
The bond’s life begins in the primary market, with a government or company issuing debt at the face value – usually US$1,000. With the help of investment banks, these bonds are sold to large pension funds, insurance companies, and other investment banks. Once the initial transaction is complete, those big buyers often sell their bonds to other investors in the secondary market.
As such, by the time retail investors buy a bond on the secondary market, its price will have fluctuated from the face value. For example, depending on the current price, you might buy the US$1,000 bond at a ‘discount’ for US$960 or at a ‘premium’ for US$1,030. If you hold a bond you paid US$960 for until maturity, you will not only collect periodic interest payments but also receive the full US$1,000 principal, pocketing an extra US$40. However, if you choose to sell before the maturity date, your return depends on the bond's current market value at that time.
Coupon rate:
The coupon rate is the fixed annual interest payment you receive, expressed as a percentage of the bond's face value – and importantly, it never changes. So if a UK bond has a face value of £1,000 and a coupon rate of 3%, the issuer will pay you £30 every year until maturity (the coupon payment), regardless of what happens to the bond's market price.
When you first look at a bond, the three things you will normally see are the coupon rate, maturity date, and the face value.
Yield:
A bond yield, however, is not fixed. It represents the return you actually receive. This depends on the price at which you bought the bond. If you buy a bond with a 3% coupon rate but pay £990 instead of the full £1,000 face value (buying at a discount), you essentially receive £30 a year with a smaller outlay, which means with a little bit of maths that your actual return is higher than 3%. You can now see why price and yield move inversely: when one goes down, the other goes up, and vice versa.
Yield to maturity:
For me personally, this is arguably the most important metric to understand. Yield to maturity (YTM), as its name suggests, is the total return if you hold the bond until the maturity date. The YTM factors in the price you paid for the bond (whether at a discount or a premium), the coupon rate payments, and the principal. What makes this important to me is that I know this number provides the full picture in a single number.
Major players in the bond market
By far, governments are the largest players in the bond market. In the US, government bonds are referred to as ‘Treasuries’; in the UK, they are called ‘Gilts’, while German bonds are labelled ‘Bunds'. Governments issue debt to fund infrastructure and public spending; this helps finance hospitals and new roads, for example, and can ultimately boost economic growth – measured by Gross Domestic Product (GDP).
Importantly, governments also issue debt to help manage existing obligations through what is known as a ‘rollover’. This replaces existing bonds with new ones, essentially extending and postponing repayment of the bill. If a government borrows £10,000 and that bond matures in two days, it can borrow another £10,000 by issuing a new bond, paying back the initial bond, and thus prolonging the debt obligation. While this gives the government more time, there are inherent risks here. Interest rate changes are the most evident risk and could result in the government paying more, as they may have to issue debt at a higher rate.
Corporations represent another major segment of the bond market, issuing debt to finance growth, execute mergers and acquisitions, or implement stock buyback programmes. As I mentioned above, some companies now issue green and sustainability-linked bonds, which are primarily used for purposes such as renewable energy.
What drives bond prices?
I am sure by now you understand that you could simply buy a bond, collect the interest payments, and hold it to maturity to receive the bond's face value. However, as I mentioned earlier, bonds also trade on the secondary market, and prices fluctuate daily.
The main driver of bond prices is interest rates. The easiest way to understand this is to imagine you are holding a bond paying 3% annual interest and the central bank announces that it will raise rates to 3.5%. What do you think will happen to your bond paying 3%? What would you do? You could keep the bond as is, continue collecting the yield, and wait until it matures, or sell it and invest in higher-yielding bonds. But who would buy your bond at 3% when they can now invest in bonds paying around 3.5%? The answer is no one. So, your bond would need to trade at a discount; its price would need to be lowered enough to compensate the investor for the loss of additional interest. This also demonstrates the key principle of bonds: price and yield move inversely.
Beyond interest rates, bond prices are heavily influenced by inflation, which erodes real returns. To help understand this connection, suppose inflation is forecast to increase; this would make your bond paying 3% less valuable. The yield you receive from your bond does not change, but your purchasing power reduces. As a result, bond investors will demand a higher return to compensate for this loss of purchasing power, and, as we know now, when yields rise, bond prices will fall. It is worth noting that there is a specific category of bond called TIPS (Treasury Inflation-Protected Securities) in the US and index-linked gilts in the UK, which are designed to protect against inflation. Both the principal and interest payments adjust in line with inflation.
Another critical driver of bonds is credit quality. While government bonds like Gilts are seen as very safe with low default risk, corporate bond prices can be highly volatile depending on the company's financial health. If a rating agency downgrades a company from ‘Investment Grade’ to ‘Junk’, investors may sell, causing the bond price to crash and yields to rise.
Are bonds ‘risky’?
For new traders, it is important to understand that while bonds can be categorised as ‘safe’ investments, I feel this is misleading. There is no such thing as risk-free in the markets (despite some financial formulas ironically using government bond yields as a proxy for the 'risk-free rate').
Nevertheless, government bonds are generally considered among the safest investments in financial markets, as they are backed by a national government. A government bond carries limited credit risk, meaning you will very likely receive your money back. This is demonstrated during periods of global uncertainty or stock market crashes, with investors often flocking to the safety of government bonds. This ‘flight to quality’ increases demand, which drives bond prices up and yields down. Conversely, during periods of strong economic growth, investors might ditch bonds for higher-growth stocks, causing bond prices to soften and yields to rise.
With that said, I want to reiterate that safe does not mean risk-free. As we know, bond prices change; therefore, if you plan to sell your bond before the maturity date, you may receive much less than you initially invested.
Naturally, if you venture into corporate bonds, credit risk will increase. Therefore, these bonds offer a higher interest rate than government issues to compensate for the additional risk. Other risks to consider, of course, are interest rate and inflation risk – which we touched on above – as well as liquidity risk (if you trade illiquid bonds, you may struggle to sell when you need to, due to the lack of buyers and sellers in that market), and currency risk, which is applicable if you trade bonds denominated in different currencies. The exchange rate will move and can either amplify or decrease your return.
How can you buy bonds?
Like most financial assets, bonds can be bought and sold in various markets. With FP Markets, you can trade global bond markets via Contract for Differences (CFDs). Given that CFDs are leveraged derivatives, you can trade bonds without assuming physical ownership, offering a more streamlined approach. Through your FP Markets trading platform, you can access global bond benchmarks, like US Treasuries and UK Gilts.
Exchange-Traded Funds (ETFs) are another popular way to trade bonds; they usually track a bond index and trade similarly to bonds. An ETF is essentially a fund that holds a collection of assets – these could be bonds, stocks, commodities, or even currencies. At its core, an ETF provides new investors with a simple and effective way to invest in a wide selection of financial instruments simultaneously, helping them diversify their portfolios without buying each asset separately.
Investors may also buy and sell bonds directly. In the US, you can buy Treasury securities through the TreasuryDirect website; in the UK, you can buy through the government’s Debt Management Office (DMO). However, it is worth noting that the DMO typically deals with institutional investors; retail investors typically buy and sell Gilts through a broker. Another point worth adding is that if you are based in the UK, investors may invest in bonds through an ISA, a tax wrapper that allows them to contribute up to £20,000 per tax year to bonds (and other assets).
What is a yield curve?
Even if you are a beginner in the bond market, I would be surprised if you had not heard or read about the yield curve. While it sounds complicated, it is actually quite intuitive and can be incredibly beneficial for traders to understand.
At its core, as shown on the chart below, the yield curve plots maturities from 1-month bonds to as far out as 30-year bonds along the X-axis, with interest rates on the y-axis. Short-term bonds under a year are called ‘T-Bills’ in the US. From 2 years to 10 years, you will often hear these referred to as ‘Notes’, while above this maturity, they are defined as ‘Bonds’.
You will find that the yield curve usually slopes upwards; naturally, as I noted in this article already, the longer the bond’s duration, the more risk you assume by locking your money away for longer periods, as a lot can change in that time. Therefore, a 10-year Note should offer more yield than, say, a 1-year T-Bill.
However, it is worth noting that the curve can also invert, where short-term yields rise above longer-term yields. This typically occurs when central banks increase their rates to help combat rising inflation (prices), and markets believe rates will fall in the future. If you look back in history, an inverted yield curve has provided a reliable predictor of recession, though, like everything in the markets, it is not infallible.
Final words
Without question, bonds deserve a place in a balanced investment portfolio, not because they are exciting, but because they are useful, help control volatility, provide income, and ultimately open the door to a different set of economic dynamics than equities do.
However, as I noted in the article, bonds are not a ‘free lunch’. Even if you buy and sell government bonds – which are considered one of the safest of investments – they carry risks. The key is to understand the role they play in your investment strategy. Even if you only trade Forex, having an understanding of what the bond market is telling you is priceless information, and that, as any professional trader worth their salt will tell you, is worth a lot. If you would like to explore the bond market, open a trading account with FP Markets today.
Written by FP Markets Chief Market Analyst, Aaron Hill
