Lesson 1: What Is a Bond?

In essence, a bond is a loan written down as a contract. You lend money now, and get more money back later. That's the basic concept; the rest are details.

People overcomplicate bonds because the word sounds technical. Underneath, it's an old idea: a loan.

There are three things that make up a bond:

• You lend money out (the investor)
• Someone borrows (the bond issuer)
• A contract binds both parties together (the bond)

What’s the difference between a bond and a favour between friends? A bond is legally enforceable while a favour is not. Someone who borrows through a bond faces real consequences if they default. This difference is the entire foundation of what makes a bond a bond.

Bonds are professionally known as Fixed Income Securities or Debt Instruments. They are commonly categorised in the following ways:

By Issuer (Who borrows the money)

• Government/Sovereign Bonds: Issued by national governments: e.g. US Treasuries, Singapore Savings Bonds, UK Gilts, German Bunds
• Municipal Bonds (commonly issued by US state or local governments)
• Corporate bonds (issued by companies)
• Agency Bonds (more common in the US, issued by local or state authorities to fund infrastructure projects)
• Supranational Bonds (issued by international organisations like the World Bank)

By Interest Structure

• Fixed-Rate Bonds: Pay the same interest rate throughout the life of the bond
• Floating-Rate Bonds: Pay variable interest rates usually based on a benchmark (such as the Secured Overnight Financing Rate or SOFR which is calculated by the US Federal Reserve Bank of New York) throughout the life of the bond
• Zero-Coupon Bonds: Pay no interest, but priced usually at a discount to redeem your principal at maturity

By Special Features

• Callable bonds: The issuer can buy back the bond early before maturity
• Puttable Bonds: The investor can sell the bond directly back to the issuer before maturity
• Convertible Bonds: The bond can be converted into a fixed number of shares of the issuing company
• Perpetual Bonds: Have no maturity date and may pay interest indefinitely

By Maturity:

• Short-term of 1 year and under: Bills (issued by governments such as US treasury bills), commercial acceptances (issued by corporates)
• Medium term of 2 to 10 years: Referred to as Bonds or Notes
• Long-term of 10 years and beyond: Usually Bond

The vast majority of all outstanding bonds issued by government and corporate issuers have no customised features and are commonly referred to as “plain vanilla” bonds by fixed income traders.

Don’t think of bonds as boring. Instead, think of them as structured. Nobody buys a bond to get rich quickly. You buy one to get paid on schedule.

Checkpoint: define a bond in under ten words.
Suggested answer: "An interest-bearing, fixed-term loan."

Now you know what bonds are and what types there are. In the next lesson, we'll break down a bond and see which four variables determine everything.