How much will the bond pay?
Imagine a government or company promises to repay $1,000 exactly one year from today and pay $40 interest on that same day. There are no payments before then. This is a hypothetical bond. Assume the borrower pays in full and on time, with no taxes, fees or early repayment.
The $1,000 repayment basis is its face value. The stated annual interest rate, called the coupon rate, is 4% of that amount, producing the $40 payment. Maturity means the date repayment is due. At maturity, the holder receives $1,040 altogether. Our bond keeps its interest fixed; some other bonds allow interest to change under their contracts.
If you sell this promise to another investor, that person still receives $1,040 at maturity. But paying $980 leaves them more profit than paying $1,020. The interest promise is unchanged; the profit relative to the amount spent has changed. That percentage gain is the return on the purchase.
What would you pay for $1,040?
Now take the buyer's side. Suppose bonds with the same repayment date and risk offer a 6% annual return. A buyer may want 6% from our bond too. Paying $1,000 and receiving $1,040 gives only 4%, so the buyer needs a lower purchase price.
Here, yield means the gain the buyer requires over one year, expressed as a percentage of the price paid.
Work backward: $1,040 must be 6% more than the amount paid today. Because this bond makes just one payment exactly one year away, the calculation is:
Price today = $1,040 ÷ (1 + required annual yield)
Scroll wide tables sideways. Keyboard: focus the table, then use the arrow keys.
| Required annual yield | Price today | Payment in one year |
|---|---|---|
| 2% | About $1,019.61 | $1,040 |
| 4% | $1,000.00 | $1,040 |
| 6% | About $981.13 | $1,040 |
For 6%, divide $1,040 by 1.06; for 2%, divide by 1.02. The displayed prices are rounded to cents. Using unrounded prices, $1,040 divided by the purchase price, minus one, gives the yield in each row. The coupon remains 4% and the future payment remains $1,040 throughout.
If the market's required yield rises immediately from 4% to 6%, the price in this example falls about 1.89%. The gap between 4% and 6% is 2 percentage points. That does not make the price fall 2%: one number measures a change in the required yield, the other a change in the price.
The table values the same bond three ways at the same moment. It does not track a holding through time, and no interest has been collected between the rows.
A bond paying interest several times needs a calculation for each payment date. Different amounts and dates produce different price responses to the same yield change. Duration is a measure used to summarise that sensitivity to a small yield change. It is an approximation, rather than a promise of an exact loss when yields move a long way.
Which interest rate has changed?
The 6% in our calculation is what buyers require from this particular bond. It is not simply a rate copied from a central bank announcement. A central bank sets monetary policy, including a short-term policy interest rate. That rate influences bond markets, but buyers also consider how long they must wait and whether the borrower will repay. One-, five- and ten-year bonds need not offer the same yield.
Buyers make those judgments before announcements as well as after them. If they already expected a rate cut and paid more for the bond, the announcement need not raise its price again. A smaller cut than expected, a changed outlook for rising prices, or doubts about repayment can leave some bond prices falling even on the day the policy rate falls.
A corporate bond is money lent to a company. If buyers become less confident that company can repay, they may demand a higher return despite a lower policy rate. When a headline says interest rates rose, identify which rate, which repayment period and which borrower it concerns before applying it to your holding.
What holding to maturity changes
If you paid $1,000 and the issuer pays the promised $1,040, a lower quotation along the way does not change that maturity payment. But if you need the money earlier, the amount available depends on the price you can sell for.
Repayment is based on face value, not whatever price you paid. Buy our bond for $1,020 and you still receive $1,040 at maturity. Under these assumptions, the one-year return is $1,040 ÷ $1,020 − 1, or about 1.96%. The 4% coupon was never a promise to pay 4% on a $1,020 purchase.
You still depend on the issuer paying as agreed. Holding to maturity still leaves the risk of default, meaning the issuer fails to pay as promised. The contract may also let the issuer repay early. Inflation and, for foreign-currency bonds, exchange rates can also affect the result. We set those aside in the example to calculate the effect of a change in yield.
Why a bond ETF is different
A fund pools investments and gives investors shares in that collection. An ETF is a fund whose shares can be bought and sold on an exchange. With a bond ETF, you own a share of the fund, rather than one particular bond. A bond inside it reaching its repayment date does not make your fund share repayable too.
An ordinary ongoing bond ETF can replace maturing bonds with new ones and keep operating. It does not promise to return your purchase amount on a fixed date. Some funds have a planned termination date, but that date alone is not a principal guarantee. Our individual bonds and bond ETFs comparison follows the cash payments in two hypothetical holdings.
Government bonds are loans to governments. A fund holding them can still lose value if their market prices fall. Cash payments from the fund, called distributions, may partly offset that fall, but the ETF's share value can drop by more than the cash received.
Look inside a bond ETF to understand its response to a rate change: government or company borrowers, short or long periods until repayment, and the payment currency all matter. For more about owning a fund share, see ETF basics. To combine cash payments with the value still invested, follow the distribution and total return example.
About the examples
All prices and yields are hypothetical. The table values the same single payment exactly one year ahead at the same point in time, assuming full repayment. It excludes taxes, fees, early redemption and currency effects. Prices are rounded to cents for display; the yield calculations use unrounded amounts. Korean guide to bond prices and rates. Editorial policy.