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— the thing the government sells in order to decrease debt. Most people have a somewhat vague understanding about what bonds are, maybe you have even heard the annoyingly persistent analogy that a bond is essentially what you do when you’re lending your friend money after they, once again, conveniently forgot their wallet at dinner. However, if you are anything like me, this analogy throws up more questions than it answers, and most other so-called “beginner friendly” explanations of bonds seem to assume some pre-existing financial knowledge that is never explicitly mentioned. So, in order to provide the resource I wish my younger self had, and to keep you from wondering exactly which member of congress you’re spotting for lunch when you purchase a bond from the US treasury, let me give you a most basic explanation of what a bond is, teaching you about some nomenclature you might encounter in this context

A bond is nothing more than an IOU, a contract that stipulates that a certain amount of money will be paid out at a specified point in the future. The amount of money to be paid is called the par rate or face value of the bond, and the time of pay-out is referred to as the maturation date. For example if Bob buys a bond from Alice, he might buy a piece of paper that reads

• In 28 days, Alice pays you $100,

with the mutual understanding that the message on the IOU will actually be carried out truthfully. In this case, the face value of the bond is $100, and the maturation date will be in 28 days’ time.

Now, it doesn’t take a mastermind to guess at why Alice wants to sell Bob such a bond: She needs $100 now, but she can only conceive of a situation where she can source $100 by some other means in 28 days. So far so good. But why would Bob want to buy this bond? I mean, what’s in it for him? Well, to incentivise Bob, Alice could do one of two things (or both, if she’s feeling fancy):

1. Alice could sell Bob the bond for less than $100, say only for $95. Then, when Bob gets $100 from Alice in 4 weeks, he will essentially have gained $5. In that case, we say that the price of the bond (the $95 Bob pays) is lower than the par rate of the bond (the $100 that Alice promises to pay).
2. Bob buys the bond for $100, but Alice offers to pay additional lumps of money leading up to the pay-out date in 28 days. For example, Alice could offer to give Bob an additional $2 every week until the maturation date. In this case, at the end of the 28 days, Bob will have received a total $108, which means he gained $8 in the process. Here, we say that Alice offers a coupon to be paid weekly of $2. Usually, the value of the coupon is quoted as a percentage of the par rate of the bond, which, in this case, is 2% (since $2 is 2% of $100).

So, it’s a win-win for both, Alice gets her $100 immediately to do with as she pleases, and Bob will have earned a little bit of extra cash in 28 days’ time.

And there you have it folks, the very basics of bonds! Of course, life wouldn’t be fun if things couldn’t get more complicated. Prices of bonds and coupons change according to the demands of the market (which, in my mind, is a bunch of middle aged people in dark blue pant suits, all shades from royal to navy, complaining about interest rates and the fact that they are still on “London time”), and can even be negotiated to an extent at treasury auctions. But, for now, I hope this very simple explanation aids you on your journey to the exciting world of investment.