The borrower makes regular interest payments until a fixed date in the future, at which time the initial amount of the loan is repaid.

This final amount returned by the bond issuer to the bondholder is called the "principal", and the interest is a series of payments called the "coupon".

Since bonds are marketable securities, they can be bought and sold like stocks in a secondary market, although there are differences between the two. Although many bonds are listed on exchanges such as the London Stock Exchange (LSE), they are usually traded in an over-the-counter (OTC) market through an institutional broker.

When interest rates rise, bonds become less attractive to investors who have the opportunity to earn high interest on other investments, causing them to fall in price. Likewise, when interest rates fall, bonds become more attractive and therefore increase in price.

How do bonds work?

Bonds are debt instruments. The bondholder lends principal to the issuer of the bond, who promises to repay the loan later in the manner stated on the bond. Typically, the issuer makes a series of pre-fixed interest payments (coupons) on a regular basis. The principal amount of the loan is repaid at the end, when the bond reaches its maturity or expiration date.

However, there are some exceptions such as zero coupon bonds and index-linked bonds.

Zero coupon bonds are those that pay no interest. In compensation, the interest on the bond is the difference between the price of the bond and the principal (or face value). For example, if you bought a bond at US$950 and received its face value of US$1000 at maturity, you would have earned 5.26% interest.

Index-linked bonds are coupon payments that vary based on fluctuations in the inflation rate. Although changes in coupon rates are calculated differently, the U.S. equivalents are "Treasury Inflation-Protected Securities" (TIPS).

Translated by: A.M