Fixed Income & Credit

Everything else on this site leans equity — stock prices, P/E ratios, DCFs. But a huge share of both banking (DCM, leveraged finance, credit) and asset management is fixed income, not equities. This lesson is the foundation: what a bond actually is, how it's priced, what a yield curve means, and how credit risk gets priced into spreads.

What a bond actually is

A bond is a loan, packaged as a tradeable security. When you buy a bond, you're lending money to whoever issued it (a government, a company) in exchange for two things: regular interest payments (the coupon) and your money back at a fixed future date (the face value, paid at maturity).

That's it — the entire instrument is defined by three numbers: face value (usually $1,000 or $100 per bond, the amount you get back), coupon rate (the annual interest rate, paid on the face value), and maturity (when you get the face value back).

Why bond prices move opposite to interest rates — the single most important fixed-income intuition

This is the concept every fixed-income interview question eventually circles back to, so get it cold: when interest rates rise, existing bond prices fall — and vice versa.

Here's why, with a real mechanism, not just a memorized rule: say you own a bond paying a 3% coupon. If new bonds start being issued paying 5% (because interest rates rose), nobody wants to buy your old 3% bond at its original price anymore — why would they, when they could get a new bond paying more? So the price of your old bond has to fall until its effective yield (coupon ÷ price, roughly) becomes competitive with the new 5% bonds. The coupon payment is fixed — it's the price that has to adjust.

Yield vs. coupon — they're not the same thing

The coupon rate is fixed at issuance and never changes. The yield is what you actually earn based on what you paid for the bond, which moves with its market price.

• Bond trading at face value (par): yield = coupon rate.
• Bond trading below face value (a "discount"): yield > coupon rate (you're getting the same fixed coupon, but you paid less for it, so your effective return is higher).
• Bond trading above face value (a "premium"): yield < coupon rate.

Yield to maturity (YTM) is the more complete version of this — the total annualized return you'd earn if you bought the bond today and held it to maturity, coupons and all. This is the number that actually gets quoted and compared across bonds.

The yield curve — what it is, and why an inverted one makes headlines

Plot the yield of bonds from the same issuer (usually the US government, since Treasuries are the cleanest reference point) against their maturities — 3-month, 2-year, 10-year, 30-year — and you get the yield curve.

Normal shape: longer maturities yield more than shorter ones. This makes intuitive sense — locking your money up for 30 years carries more risk (inflation could erode your fixed coupon, the issuer could face more can-happen-in-30-years risk) than locking it up for 3 months, so investors demand more yield to compensate.

Inverted yield curve: short-term yields exceed long-term yields — genuinely unusual, and one of the most closely watched recession-warning signals in markets (specifically the 10-year vs 2-year spread going negative). The logic: if investors expect the central bank to cut rates sharply in the future (because they expect a slowdown), they'll accept a lower yield on long-dated bonds now to lock in today's still-higher rate before it's gone — pulling long-end yields below short-end yields.

You can see a real bank's current policy rate and how it's moved on this site's own Central Bank Room — the policy rate is the anchor the short end of every yield curve is built around.

Credit spreads — how bond markets price default risk

Not every bond has the same risk of the issuer failing to pay you back. A US Treasury is treated as essentially default-risk-free (the government can, worst case, print the money). A struggling company's bond carries real default risk. The market prices that difference as a credit spread — the extra yield a risky bond pays over a same-maturity Treasury.

• Investment grade (IG): rated BBB-/Baa3 or higher (S&P/Moody's scales) — lower default risk, tighter spreads.
• High yield (HY, "junk"): rated below that — real default risk, much wider spreads, more volatile in a downturn (spreads widen sharply when investors get nervous about defaults, which is why "credit spreads blowing out" is a classic recession-fear headline).

The mechanics: if a BBB-rated company's bond yields 5.5% while a same-maturity Treasury yields 4%, that company's credit spread is 1.5 percentage points (150 basis points) — the market's real-time price on "how likely is this company to not pay me back."

Duration — the one number that tells you how much a bond's price will move

Duration is a measure of a bond's sensitivity to interest rate changes, expressed in years. As a rule of thumb: a bond with a duration of 7 will lose roughly 7% of its value if rates rise by 1 percentage point (and gain roughly 7% if rates fall by 1 point).

Two things drive duration higher: longer maturity (more years for rate changes to matter) and lower coupon (more of the bond's value sits in the single final face-value payment, further in the future, rather than being returned earlier via coupons — a zero-coupon bond has the highest duration of all for its maturity).

Convexity is the next-level refinement: duration itself isn't perfectly constant — it changes as rates move, and convexity measures that curvature. You don't need to compute convexity by hand for a first-round interview, but knowing that duration is an approximation, not an exact formula, is the kind of nuance that separates a real answer from a memorized one.

What this actually looks like in an interview

A realistic fixed-income technical question isn't "define duration" — it's something like: "A company's credit rating gets downgraded from A to BB. What happens to its existing bonds' prices, and why?" Answer: the credit spread widens (the market now demands more yield for the added default risk), and since the coupon is fixed, the bond's price has to fall to make the yield line up with that wider required spread — the exact same "price adjusts because coupon can't" mechanism from earlier in this lesson, just triggered by credit risk instead of rate risk.

That's the actual skill this lesson is trying to build: not memorizing definitions, but being able to trace why a bond's price moves, from first principles, under a scenario you haven't seen phrased that exact way before.