What is a bond, and how are they priced? A bond is a loan that the bondholder, the individual who purchased the bond, makes to the bond issuer, either a government or a corporation who is looking to raise money. A bond pays periodic interest called coupon payments as well as the principal amount at the end, called the maturity.

Bonds can be classified into many different categories as there are numerous issuers and types of securities. The biggest ones, however, include the following: U.S. Treasuries (issued by the U.S. Department of Treasury), Corporate Bonds (issued by corporations), High-Yield Bonds (also known as "junk" bonds), Agency bonds (issued by government-sponsored enterprises), mortgage-backed securities (MBS), asset-backed securities (ABS), Municipal bonds, and collateralized Debt Obligations (CDOs).

Bonds with longer maturities, or the date when the full amount of the bond is due, are associated with higher risk because the bondholder is lending money for a longer period of time and there are more factors that can affect the bond issuer's ability to repay the bond in a 10 year time frame versus a 10 month time frame, for example. The bondholder takes on more risk but this also means that they have the potential to earn greater return.

Additionally, bonds have credit ratings which essentially assess the likelihood that the bond issuer will default or fail to repay the loan. Bonds with higher credit ratings are considered safer and therefore will pay a lower interest rate because the associated risk for the bondholder is lower.

Bonds do not have to be purchased directly from the issuing entity. They can be bought and sold on the "secondary market" (also known as the open market). A bond's price and yield (the actual annual return that an investor can expect to receive if the bond is held to maturity and is based on the purchase price and coupon). Bond prices always move in the opposite direction of interest rates and yields. If interest rates rise, prices fall and yields rise. If interest rates fall, prices rise and yields fall. When interest rates fall, older bonds (which were sold during high interest rates) are now more valuable and bondholders can charge a premium for them. Bond prices are usually quotes as a percentage of the face value. If the bond is quoted as 99 then its price is $990 for every $1000 and it is trading at a discount. If the bond is quoted as 101 then its price is $1010 for every $1000 of face value and the bond is trading at a premium. If it is quoted as 100 then it is trading at par (face value).