A bond is the simplest financial promise that exists at scale: a borrower agrees to pay the lender a fixed schedule of cash flows — periodic coupons plus a final return of principal — on stated dates, in exchange for cash today. If you remember nothing else from this course, remember that. Every other complication in fixed income is a refinement of this single skeleton.
The global bond market is roughly $140 trillion in size — several multiples of the global equity market. Governments are the largest issuers, with US Treasuries alone accounting for more than $28 trillion outstanding. Corporate bonds, mortgage-backed securities, municipal bonds, and emerging-market eurobonds fill out the rest. When financial commentators speak of 'the market', the equity market gets the headlines, but the bond market sets the discount rate that prices everything else.
The four basic terms
- Principal (also called face value or par): the amount the issuer borrows and promises to return at maturity. Conventionally USD 1,000 for US corporate bonds, KES 50,000 or KES 1,000,000 for Kenyan T-bonds.
- Coupon: the periodic interest payment, usually quoted as an annual percentage of par. A 6% annual coupon on a USD 1,000 bond pays USD 60 a year (split into two USD 30 semi-annual coupons in US convention).
- Maturity: the date the principal is repaid. Short bonds (under 1 year) are usually called bills or notes; intermediate (1-10 years) and long bonds (10-30 years, with occasional 50- and 100-year issues) differ mostly in their duration risk.
- Yield: the discount rate that equates the present value of all promised cash flows to the current market price. Yield moves with the market; coupon is fixed at issuance.
The cash-flow view
Once you internalise that a bond is just a sequence of dated cash flows, every fixed-income calculation becomes routine. Duration is a sensitivity of those cash flows' present value to a yield change. Convexity is the curvature of that relationship. Spread is the extra yield required to compensate for credit risk. You will never go far wrong returning to the cash-flow view.
Why bonds matter beyond fixed income
The yield on a government bond of a particular maturity is the closest thing finance has to a 'risk-free' rate for that horizon. Every equity discount rate, every project NPV, every option price builds from that anchor. When the US 10-year Treasury yield moves 50 basis points, the value of every dollar of future cash flow on the planet repricing. The bond market is the gravitational centre of finance, and a serious analyst learns to read it before anything else.
The four canonical bond risks
- Interest-rate risk: if market yields rise, the present value of fixed future coupons falls. Duration measures this exposure.
- Credit risk: the issuer may fail to pay coupons or principal. Ratings and spreads price this risk.
- Liquidity risk: in stressed markets, a bond cannot always be sold at a fair price. Off-the-run Treasuries trade wider than on-the-run; corporate bonds far wider than Treasuries.
- Reinvestment risk: coupons must be reinvested at prevailing rates. If yields fall over the bond's life, total return falls below the original yield to maturity.
Bonds in the capital-structure hierarchy
If a company is liquidated, bondholders are paid before equity holders. Within bonds there is a further hierarchy: senior secured (paid first, with specific collateral), senior unsecured, subordinated, and finally hybrid instruments such as convertible and contingent-convertible bonds. The seniority is the single biggest determinant of recovery in default, which is why credit analysts spend so much time on indenture language.
The first habit
Open Bloomberg, Tradeweb, or any free yield aggregator (CBK weekly auction bulletin, FT bond data) and read the 10-year sovereign yield for three markets every morning before you read anything else. US Treasury, Bund, Kenyan T-bond. Internalise the levels and the moves. Within a quarter, you'll start to feel the rhythm of the bond market the way an FX trader feels currencies.
Exercise
A 5-year USD bond pays a 7% annual coupon on USD 1,000 par. Write out the eleven dated cash flows (year 0 through year 5) from the bondholder's perspective if the bond is purchased at par.