Module One

Bonds and how they work

Bonds are securities issued by governments‭, ‬government agencies or companies to provide them with finance‭. ‬These borrowers‭ (‬also‭ ‬called issuers‭) ‬pay bondholders‭ (‬lenders‭) ‬an interest rate‭ (‬the coupon‭), ‬typically over a set timeframe‭. ‬Bondholders receive regular coupon payments and get back the amount they invested‭ (‬principal‭) ‬when the bond matures‭.‬

Governments issue bonds to finance projects‭, ‬such as building a hospital or school‭. ‬Companies issue bonds to finance growth‭, ‬buy‭ ‬equipment or another business‭. ‬Bonds can also be issued to refinance existing ones‭. 

The bond market is the world’s largest securities market with‭ ‬US$145‭ ‬trillion outstanding‭. ‬The United States is the largest‭, ‬followed by China and Japan‭.‬1

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Principal

The amount borrowed/lent

Maturity

The date of the principal repayment

Coupon

The interest rate paid on the principal

Example 5‭ year bond‭: Coupon‭: 7%‭ | Maturity: 5‭ years‭ | Principal: 100‭

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Types of bond

Bonds can be classified in various ways:

by issuer type‭, ‬credit rating‭, ‬duration‭, ‬seniority and structural features‭.

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By Issuer

By Issuer

By Rating

By Rating

By Geography

By Geography

By Duration

By Duration

By Seniority

By Seniority

By Features

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Main risks impacting bonds

Bonds provide a regular income and are typically less volatile than equities‭. ‬They can provide diversification benefits in a portfolio‭. ‬However‭, ‬investing in bonds involves several risks‭. ‬The biggest of these is default/credit risk‭, ‬when the issuer is unable to repay the principal or coupon‭.

Interest rate risk is the other key risk because of the inverse relationship between rates and bond prices‭. ‬When rates rise‭, ‬bond prices fall and vice versa‭. ‬Other risks include liquidity‭, ‬inflation and reinvestment risk‭.

Main bond risks

Credit risk

An issuer of a bond is not able to meet payments of the‭ ‬principal or coupons‭.‬‬

Interest Rate Risk

An increase or decrease in interest rates impacts the value of a bond‭.‬‬

Illiquidity risk

Investors not‭ ‬ able to quickly‭ ‬convert an asset‭ ‬into cash without‭ significantly‭ affecting its price‭.‬‬

Reinvestment risk

Investors not being able to reinvest cash flows‭, ‬such as coupon payments‭, ‬at a rate equal to their current return‭.‬

Inflation risk

A rise in inflation will erode the value of an investment through the decline in‭ ‬purchasing power‬

Bond issuance and‭ ‬new issue premia

Bonds are issued via auction‭.

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The auctioneer‭ (‬bank representing the issuer‭) ‬starts the auction with a‭ ‬‘high’‭ ‬yield to attract bidders‭, ‬who signal their interest by placing orders at the initial yield‭. ‬The auctioneer then lowers the yield‭, ‬with bidders able to confirm‭, ‬withdraw or reduce their order‭. ‬Typically‭, ‬this happens in 3‭ ‬stages‭: ‬initial price talk‭, ‬guidance and final pricing‭.

New issue premia is the extra spread investors are paid to invest in a new issue relative to an issuer’s existing bonds‭. ‬Different factors can influence the level of premia‭, ‬including investor demand and market conditions‭.

Bond auction process example

1‭. ‬Initial price talk‭ (‬IPT‭)‬‬

4.50%

Investor 1

Investor 2

Investor 3

Investor 4

Investor 5

Investor 6

2‭. ‬Guidance‬‬

4.25%

Investor 1

Investor 2

Investor 3

Investor 4

Investor 5

Investor 6

3‭. ‬Final Pricing‬

4.00%

Investor 1

Investor 2

Investor 3

Investor 4

Investor 5

Investor 6

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DISCLAIMER

This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice. It is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are subject to change.

  1. Source: SIFMA Research as of July 2025.
  2. Moody’s Ratings as of February 28, 2025. Most recent available data used.‬

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