Bonds Explained: What a $1,000 Bond Pays You by the End

7. What is a bond, really

Bonds promise interest, then repayment on a set date. Here is how bonds pay you, in seven parts. Number seven: what is a bond, really? A bond is a debt security, like an IOU, a market regulator's investor guide says.

When you buy one, you lend money to the issuer for a set amount of time. The issuer promises to pay interest during the bond's life and to repay its face value when it matures. That repayment is the principal, also known as the face value or par value. Unlike a share, a corporate bond gives you no ownership in the company, an industry regulator's guide says.

Bonds are issued by governments, cities and companies, and even by international bodies, that guide says. The vast majority of bonds have a maturity date set when they are issued, that guide says. On that date, the borrower pays the final interest payment and the bond's face value. Bond rules and taxes differ where you live.

Borrowers issue bonds for a reason, and number six shows what they pay for. Subscribe for the next parts of this series: every source here is an official investor guide, linked below.

6. Why do governments and companies borrow through bonds

Number six: why do governments and companies borrow through bonds? Governments and companies issue bonds to raise money for projects like schools, highways and hospitals, a market regulator's guide says. Most corporate bonds are issued with maturities from one to thirty years, an industry regulator's guide says. Generally, bonds maturing in one to three years are short-term, in four to ten years intermediate, and over ten years long-term, it adds.

Many bonds pay a fixed rate of interest for their whole term, the market regulator's bulletin on corporate bonds says. With a fixed rate, the payments stay the same whatever happens to market interest rates. Other bonds have floating rates that reset from time to time, such as every six months. A floating rate follows a benchmark, for example a government bond rate plus 1%.

Which bonds you can buy differs where you live. Either way, a bond pays on a schedule, and number five shows how much.

5. How much does a bond actually pay you along the way

Number five: how much does a bond actually pay you along the way? Most bonds are fixed income securities, with fixed interest payments until maturity and then the principal back, an industry regulator's guide says. Interest payments on a bond are called coupon payments, and the rate is called the coupon rate, the bulletin explains. The coupon is set when the bond is issued and tied to its face value, an industry regulator's guide says.

In its example, a one-thousand-dollar bond with a 4% coupon pays $40 a year. In that example, interest is paid twice a year, so the bond pays $20 every six months. It also pays back the $1,000 at the end of its ten years. Some bonds pay no interest until they mature, and these are called zero-coupon bonds.

In the bulletin's example, an investor pays $800 for a five-year zero-coupon bond with a one-thousand-dollar face value. At maturity it pays $1,000: the $800 price plus $200 of interest. By our count, that $200 over five years averages $40 a year. If you sell between coupon dates, the buyer pays you the interest added up since the last payment, the industry guide says.

Payment schedules and taxes on interest differ where you live. Who borrows matters too: number four explains why.

4. Why do some bonds pay more interest than others

Number four: why do some bonds pay more interest than others? Credit ratings try to estimate a bond's credit risk, based on the borrower's ability to pay, a market regulator's bulletin says. Investment-grade bonds are considered more likely than non-investment-grade bonds to be paid on time. Non-investment-grade bonds, also called high-yield bonds, generally offer higher interest rates to make up for greater risk.

Rating agencies review their ratings from time to time and may change them. Time matters too: long-term bonds generally offer higher coupon rates than short-term bonds of the same credit quality. That extra rate pays investors for the risk that rates change before the bond matures. By our count, on $1,000, each extra percentage point of coupon adds $10 a year.

How ratings work differs where you live. That's four of the seven: what a bond is, why borrowers issue them, what they pay, and what the rate says. Next, why a bond's price moves even though its payments don't.

3. Why does a bond's price move if its payments are fixed

Number three: why does a bond's price move if its payments are fixed? A fixed-rate bond's face value and interest stay fixed for its life, an industry regulator's guide says. But if you buy or sell it after it was issued, its price often moves above or below its face value. Market interest rates and bond prices generally move in opposite directions, like the two ends of a seesaw, a market regulator's bulletin says.

In its example, a ten-year bond pays a 3% coupon on $1,000. If, a year later, market rates fall to 2%, that bond's price rises to $1,082. If market rates rise to 4% instead, its price falls to $925. Bond prices are often quoted as a percentage of face value: at 105, a one-thousand-dollar bond costs $1,050.

At ninety-five, it costs $950, the industry guide adds. Longer maturities and lower coupon rates generally mean bigger price changes when market rates change, the bulletin says. A measure called duration, stated in years, signals how much a bond's price is likely to move when rates change. Other things move the price too, such as a change in the bond's credit rating or in supply and demand, that guide says.

A government guarantee covers a bond's payments and principal, but not its market price if you sell early, the bulletin says. Market rules differ where you live. In one breath: a bond is a loan, it pays on a schedule, riskier borrowers pay more, and its price moves opposite to rates. If you want to see how rising prices affect fixed payments, the video on protecting your money from inflation is linked on screen.

So the price you pay matters: number two shows how much.

2. Does the price you pay change what you earn

Number two: does the price you pay change what you earn? Yes, and the measure is yield to maturity, the yearly return if you hold the bond to maturity, the bulletin says. In its example, three ten-year bonds each pay $40 a year and $1,000 at the end. Bought at $1,000, the yield to maturity is 4%.

Bought at $900, it is 5.31%. Bought at $1,100, it is 2.84%. A bond often trades above or below its face value when market rates move away from its coupon rate, the bulletin says. By our count, the nine-hundred-dollar bond still returns 1,000 at maturity, a hundred dollars more than it cost.

Those payments depend on the borrower paying on time, which the bulletin calls credit or default risk. If you sell before maturity, the price you receive depends on where the bond trades that day, the industry guide says. In its example, a 5% coupon with 8% inflation means the interest buys less. Bond protections differ where you live.

Before number one, a guess: a one-thousand-dollar bond at 4%, held ten years, pays how much in all?

1. What does a thousand-dollar bond certificate pay you by the end

Number one: what does a thousand-dollar bond certificate pay you by the end? By our count, $40 a year for ten years is $400 of interest. By our count, $400 of interest plus the 1,000 repaid at maturity makes 1,400 in all. Held until maturity, a bond keeps paying its stated interest and then its face value, subject to default risk, the bulletin says.

That's why, if you plan to hold to maturity, day-to-day price swings may matter less to you, it adds. With a corporate bond, you receive only the interest and principal, no matter how profitable the company becomes, the bulletin says. If the company runs into difficulties, it still has a legal obligation to make timely payments of interest and principal, it adds. It has no similar obligation to pay dividends to its stockholders.

Some bonds can be called, which means the issuer may repay them early if rates fall, much like refinancing a mortgage. Bond rules, fees and taxes differ where you live. That is how bonds pay you: interest along the way, the face value at the end, and a price that moves opposite to rates. So, seven parts: what a bond is, why borrowers issue them, what they pay along the way, and what the rate says.

Then why prices move, why your purchase price matters, and what you receive at the end. Today, you can open a market regulator's guide to bonds, linked below, and read how it explains interest rate risk. Which of the seven surprised you most? Tell us the number in the comments.

Results vary, rules differ where you live, and this is information only, not financial advice. This is Wealth Filings. If you want to see part twelve, subscribe now: it shows what moves the price of a home. Next on Wealth Filings, How Money Really Works, part twelve: why home prices rise.