4 Chapter 4 of 10 · 10 min read · Updated September 22, 2026
Bonds and Treasuries
A bond is a loan you make. This chapter covers how it pays, why prices and yields move in opposite directions, which kinds exist, and what bonds are for.
Core facts
- A bond is a loan. You lend money to a government or company. It pays you interest on a schedule and returns the original amount on the maturity date.
- U.S. Treasuries are loans to the federal government and are treated as the lowest-risk dollar asset. Bills mature in a year or less, notes in 2 to 10 years, bonds in 20 or 30 years.
- Bond prices and interest rates move in opposite directions. When new bonds pay 5%, nobody will pay full price for your old 3% bond, so its price falls.
- Yield is the yearly return you get if you buy at today's price and hold to maturity. Longer bonds usually yield more and swing more in price.
- Treasury interest is taxed by the federal government but exempt from state and local income tax.
- Companies pay higher yields than the Treasury because they can fail to pay. Credit ratings from AAA down to junk grade that risk.
- You can buy Treasuries with no fee at TreasuryDirect.gov, or hold a bond index fund in any broker account.
- Bonds are in a portfolio to reduce swings and pay income, not to grow fastest. Over most long periods, stocks have returned roughly double what bonds have.
What a bond is
When a government or company needs money, it can borrow from investors by issuing bonds. Each bond has four parts:
- Face value (or par): the amount repaid at the end, usually $1,000.
- Coupon: the interest rate, fixed when the bond is issued. A 4% coupon on $1,000 pays $40 a year, usually in two $20 payments.
- Maturity: the date the face value is repaid.
- Issuer: who owes you the money. This decides how safe the bond is.
Buy a $1,000 10-year Treasury note with a 4% coupon and hold it: you receive $40 a year for ten years, then $1,000 back. Nothing else happens. The complications come only if you sell before maturity or if the issuer cannot pay.
Types of U.S. Treasuries
| Type | Maturity | How it pays | Notes |
|---|---|---|---|
| Treasury bill (T-bill) | 4 to 52 weeks | Sold below face value; you get face value at maturity. No coupon. | Closest thing to cash that pays a market rate. |
| Treasury note | 2, 3, 5, 7, 10 years | Coupon every six months | The 10-year note's yield is the benchmark quoted in the news. |
| Treasury bond | 20 or 30 years | Coupon every six months | Highest yield, biggest price swings. |
| TIPS | 5, 10, 30 years | Face value rises with CPI; coupon paid on the adjusted value | Built-in inflation protection. Interest taxed yearly. |
| I bond | Up to 30 years | Fixed rate plus an inflation rate reset every six months | Only at TreasuryDirect; $10,000 per person per year; locked for 1 year; lose 3 months' interest if cashed before 5 years. |
Other issuers:
- Corporate bonds: issued by companies. Higher yield, real default risk.
- Municipal bonds: issued by states and cities. Interest is usually free of federal tax, which makes them attractive mainly to high earners in taxable accounts.
- Agency bonds and mortgage bonds: issued by government-linked entities; slightly more yield than Treasuries.
Why price and yield move in opposite directions
A bond's price is the present value of its remaining payments (Chapter 1). Your bond's coupon is fixed. Market rates are not. When rates change, the value today of those fixed payments changes, and the price adjusts so that a new buyer gets the market rate.
Example: you own a 5-year, $1,000 bond paying 3%. Rates rise and new 5-year bonds pay 4%. Nobody will pay $1,000 for your 3% bond when 4% is available. Its price falls to about $955, where its $30 a year plus the $45 gain at maturity works out to roughly 4% for the buyer. If rates had fallen to 2%, the price would rise to about $1,047.
How much a bond's price moves per 1% change in rates is its duration, measured in years. It is a little under the years to maturity for short bonds and well under it for long ones, because the coupons arrive before the face value.
| Bond | Approx. duration | Price change if rates rise 1% |
|---|---|---|
| 1-year bill | 1 | about −1% |
| 5-year note | 4.6 | about −4.6% |
| 10-year note | 8.5 | about −8.5% |
| 30-year bond | 17 | about −17% |
Three things follow:
- If you hold to maturity, price swings do not matter. You get every coupon and the face value.
- A bond fund never matures, so its price rises and falls with rates permanently. In 2022, when rates rose about 4 points in a year, the broad U.S. bond index fell 13%, its worst year on record.
- Short bonds are for safety. Long bonds are a bet on rates falling.
The risks
| Risk | What it is | Who has it |
|---|---|---|
| Interest-rate risk | Rates rise, your bond's price falls. | Everyone, in proportion to duration. |
| Inflation risk | Fixed payments buy less over time. A 4% bond during 5% inflation loses buying power. | Everyone except TIPS and I bond holders. |
| Credit risk (default risk) | The issuer does not pay. | Corporate and municipal bonds. Near zero for Treasuries. |
| Reinvestment risk | Your bond matures when rates are low and you cannot replace the income. | Anyone living on bond income. |
Credit ratings from Moody's, S&P, and Fitch grade default risk: AAA (safest) down through BBB, which is the lowest investment grade. Below that is high yield, also called junk: higher coupons, real chance of loss. Junk bonds behave more like stocks in a crisis than like Treasuries.
How to buy bonds
| Method | How | Best for |
|---|---|---|
| TreasuryDirect.gov | Open a free account, link a bank, buy bills, notes, bonds, TIPS, and I bonds at auction with no fee. | Holding specific Treasuries to maturity; I bonds (only sold here). |
| Broker account | Buy individual Treasuries and corporate bonds, new or secondhand. Treasuries are usually commission-free; corporates carry a markup. | Holding Treasuries inside an IRA. |
| Bond index fund or ETF | One fund holds thousands of bonds. A total bond market fund holds Treasuries, agency, and investment-grade corporate bonds; expense ratios around 0.03% to 0.05%. | Most people. Automatic, diversified, no maturity dates to manage. |
| Money market fund | A fund of very short bills and similar; price stays at $1, pays a rate close to the Fed's. | Cash you want earning interest inside a broker account. |
A useful rule: held for about as long as its duration, a high-quality bond fund tends to return close to its starting yield, whatever rates do in between. Rising rates cut the price first, then let the fund reinvest at higher yields, and the two roughly cancel over that period. The yield you buy at is the best forecast you have.
A bond fund's key numbers: its duration (how much it swings), its credit quality (how much is government vs. corporate), and its yield to maturity (what it currently pays). "Short-term" funds have durations under about 3; "intermediate" around 5 to 7; "long-term" over 10.
What bonds are for
Bonds do two jobs in a portfolio:
- Cushion. When stocks fall sharply, high-quality bonds usually hold value or rise, because investors flee to safety and the Fed cuts rates. In 2008 the S&P 500 fell 37% and the U.S. bond index rose 5%.
- Income. Predictable payments, useful when you are spending from the portfolio rather than adding to it.
The classic mix is 60% stocks, 40% bonds, which has captured most of the stock market's return with far smaller drops. Younger investors with decades ahead often hold 10% to 20% in bonds or none at all; investors near retirement hold more. Chapter 9 gives a framework.
The cushion is usual, not guaranteed. In 2022 stocks and bonds fell together, because the cause was rising rates rather than a recession. Short-term Treasuries and cash held up; long bonds did not.
Common mistakes
- Assuming "bond" means "safe." A 30-year bond can lose 17% in a year; a junk bond can default.
- Buying a long-term bond fund for cash you need soon. Match the fund's duration to your horizon.
- Chasing yield. A bond paying 9% when Treasuries pay 4% is paying you for a real chance of losing the principal.
- Holding bonds in a taxable account while holding stocks in an IRA. Bond interest is taxed as ordinary income; it belongs in the tax-sheltered account where possible.
- Ignoring inflation. A bond that pays 3% during 4% inflation is a slow loss.
Remember
- A bond is a loan: coupon on a schedule, face value at maturity.
- Rates up, prices down. Duration tells you how much.
- Treasuries carry no default risk and no state tax. Corporates pay more because they can fail.
- A total bond index fund is the simple way to own bonds; TreasuryDirect is the free way to own specific ones.
- Bonds cushion and pay income. Stocks grow. You usually want both.
- A bond's price is the present value of its payments. The yield you buy at is the best forecast of what you will earn.
Common questions
Are Treasury bonds really risk-free?
Free of default risk: the U.S. government has always paid. Not free of interest-rate risk, which can cut a long bond's price sharply if you sell before maturity, nor of inflation risk.
Should I buy individual bonds or a bond fund?
A fund for most people: it is diversified, cheap, and automatic. Individual Treasuries make sense when you want a known amount on a known date, such as money for a house purchase in three years.
Do bonds protect against inflation?
Ordinary bonds do not; their payments are fixed. TIPS and I bonds are designed to, because their value or rate rises with CPI.
What does the 10-year Treasury yield tell me?
It is the market's reference interest rate. Mortgage rates, corporate borrowing costs, and stock valuations all move with it. Rising means money is getting more expensive; falling means cheaper.
How do bonds fit in a diversified portfolio?
They reduce how far the portfolio falls in a stock crash and pay steady income. The share you hold usually rises as you get closer to needing the money.