A bond is a type of fixed income investment that may be used to generate income. Typically, a bond issuer sells bonds to investors. In return, the issuer delivers to investors interest payments (or “coupons”) until the bond matures and then delivers the bond’s face value at maturity.
A bond ETF is an exchange-traded fund that holds bonds. The world of bond ETFs includes corporate bond ETFs, municipal bond ETFs, and Treasury bond ETFs, but there are many other types of bond funds even within those categories.
A bond fund is any mutual fund or ETF that invests in bonds in some way.
A bond ladder is the strategy of owning bonds with staggered maturities, holding each bond until it matures, and collecting fixed amounts of interest and principal on fixed dates—“fixed income” in its truest form. A bond ladder can be designed to generate cash flow at different frequencies—e.g., monthly, quarterly, or annually—through the spacing between the rungs of the ladder (i.e., when each bond matures). For details, read our article How To Build a Bond Ladder.
A bond ladder ETF is an ETF that maintains a bond ladder strategy within the ETF. LifeX is an example of a bond ladder ETF.
A callable bond is a bond that can be repaid by the issuer before its maturity date. Typically, these kinds of bonds may offer a higher yield to compensate for the risk that the bond is called before its maturity date.
A corporate bond is a bond issued by a company. Broadly, corporate bonds typically offer higher yields than government or municipal bonds, though they carry more risk because they are backed by the credit of the individual company issuing them.
There are two common classifications of corporate bonds: investment grade corporate bonds and high yield corporate bonds.
A bond’s coupon rate is the annual interest its issuer plans to pay the bond’s holders, assuming the issuer does not default.
A credit rating is an assessment of a bond issuer’s creditworthiness, performed by third-party agencies like Fitch, Moody’s, or S&P. An issuer’s credit rating may affect the coupon rate of the bonds it issues.
Credit risk refers to the risk of investing in a fixed income security that is related to the credit quality of the bond issuer. In general, if a bond issuer has a higher credit rating, its bonds should carry lower credit risk (and vice versa).
Duration is a measure of how much a bond's price is likely to change if interest rates move. In general, the longer a bond’s duration, the more sensitive its price will be to changes in interest rates.
A bond’s face value (or par value) is the amount of money a bond issuer promises to repay bondholders at maturity, and it determines the dollar value of coupon payments. It is typically repaid in full as a lump sum at the bond’s maturity date, assuming the issuer does not default.
A fixed income ETF is any ETF designed to invest in fixed income instruments, including treasury, municipal, or corporate bonds.
A floating rate bond is a bond whose interest rate may change or “float” over time.
A high yield bond (also known as a “junk bond”) is a corporate bond issued by a company with a credit rating at or below a certain rating on the credit rating scale (i.e., BB+ on S&P or Fitch’s scales or Ba1 on Moody’s scale).
These bonds typically offer higher yields than investment grade corporate bonds and government bonds because they carry a higher risk of default (i.e., less likely to be able to repay its debts on time).
Inflation risk refers to the potential for the purchasing power of your cash to go down over time as the prices of goods and services rise (i.e., due to inflation). In other words, it is the risk that $1 won’t buy you as much in the future as it can today. In the context of fixed income, it is important to consider how inflation may erode the purchasing power of coupon payments you expect to receive in the future.
Interest rate risk is the risk that changing interest rates will negatively affect the value of your investments or potential future investments.
An investment grade bond is a corporate bond issued by a company with a credit rating at or above a certain rating on the credit rating scale (i.e., BBB- on S&P or Fitch’s scales or Baa3 on Moody’s scale).
These bonds typically offer higher yields than government bonds but lower yields than high yield corporate bonds, because the issuer has been deemed likely to meet its obligations.
A bond’s maturity date is the stated end of the bond’s term. For example, if you invest in a Treasury note with a hypothetical maturity date of 12/31/2035, you can expect to receive regular interest payments (based on the coupon rate) between now and December 2035. In addition, you can expect to receive your principal back at the end of 2035.
Reinvestment risk is the possibility that when you receive cash flows from an investment, you may not be able to reinvest that money at the same or a higher rate of return as your original investment.
For fixed income investments, reinvestment risk typically relates to the possibility that you may have to reinvest coupon payments or principal from a maturing bond at lower interest rates than your initial investment.
Spread is a term that is used to describe the difference in yield between two bonds.
A U.S. municipal bond is a bond issued by state or local governments in the U.S., whose payments are thus backed by the credit of those government entities. In some instances, these bonds may offer tax-free interest income depending on where you reside and which bond you own.
A U.S. Treasury bond is a bond issued by the U.S. federal government, whose payments are thus backed by the credit of the U.S. government. Because the U.S. government has a high credit rating determined by third-party companies, these are considered among the safest investments.
The yield to maturity is the total return you can expect to receive from a bond if you hold it to maturity after buying it.
A zero coupon bond is a bond that does not deliver any periodic coupon payments and then delivers its full par value or face value at maturity.