Bonds Explained: Government, Corporate, and Interest Rates

A bond is essentially a loan — when you buy a bond, you're lending money to whoever issued it (a government or a company) in exchange for regular interest payments over a set period, and the return of your original investment when the bond matures. Bonds are generally considered lower-risk than stocks because bondholders are legally entitled to be repaid before shareholders in the event the issuer runs into financial trouble.

Government bonds — issued by national governments — are typically viewed as some of the safest available investments, particularly those from economically stable countries, since a government has more tools available to meet its debt obligations than most companies do. Because they're perceived as low-risk, government bonds generally pay lower interest rates than other types of bonds.

Corporate bonds are issued by companies and typically pay higher interest rates than government bonds, compensating investors for the added risk that a company — unlike a government — can go bankrupt and fail to repay its debt. Corporate bonds are rated by credit rating agencies (from highest-quality "investment grade" down to riskier "high-yield" or "junk" bonds), and the rating strongly influences both the interest rate offered and the actual risk of default.

Bond prices and interest rates have an important inverse relationship worth understanding: when interest rates rise, existing bonds paying the old, lower rate become less attractive compared to new bonds paying the higher rate, so their market price falls; when interest rates fall, existing higher-paying bonds become more attractive and their price rises. This is why bonds, despite being considered relatively conservative, can still lose value in the short term — particularly during periods when a central bank is actively raising interest rates.