How the bond market works: price, yield, duration and the yield curve
By the MeridIAn Screener team · Published on 13 October 2026 · 6 min read
The bond market is bigger than the stock market and sets the price of money for everyone: governments, companies and households. Even if you only own stocks, understanding bonds helps you understand why the market goes up or down. This guide explains, with numbers, why a bond’s price falls when rates rise, what duration is and what the yield curve says.
What a bond is
A bond is a loan you make to a government or a company. In return you receive regular interest (the coupon) and, at the end of the term (maturity), you get back the amount lent (the face value).
| Term | What it is | Example |
|---|---|---|
| Face value | What you get back at maturity | $1,000 |
| Coupon | Annual interest on the face value | 3% = $30 a year |
| Maturity | When you get the face value back | In 10 years |
| Price | What it costs today on the market; it changes every day | $918, $1,000, $1,090… |
| Yield to maturity | The annual return you get if you buy at that price and hold to maturity | 4% |
The US Treasury issues bills (4 weeks to 1 year, no coupon: you buy below face value and get the full amount at maturity), notes (2 to 10 years), bonds (20 and 30 years) and TIPS, whose principal rises with inflation. Companies and states and cities (municipal bonds, usually free of federal tax) issue bonds too; companies pay more because they carry more risk.
Why the price falls when rates rise
It’s the key idea and the most confusing one. Imagine you buy a 10-year bond for $1,000 that pays 3%. The next day rates rise and new bonds pay 5%. Nobody will pay you $1,000 for a bond paying $30 a year when for the same money they can have one paying $50. To sell it you’ll have to lower the price until it also yields 5% to the buyer.
| If market rates move to… | The 3%, 10-year bond is worth | Change |
|---|---|---|
| 2% | $1,090 | +9% |
| 3% (same as its coupon) | $1,000 | 0% |
| 4% | $919 | −8% |
| 5% | $846 | −15% |
Price and yield always move in opposite directions. If you hold to maturity and the issuer pays, you’ll get your $30 a year and your $1,000 at the end whatever happens to the price; the loss only becomes real if you sell early. But in the meantime you’ll have earned 3% when you could have earned 5%.
Duration: how much a rate rise hurts
Duration measures how sensitive a bond’s price is to rates. The rule of thumb: if rates rise 1 point, the price falls by roughly a % equal to the duration. The longer the maturity and the lower the coupon, the higher the duration.
| Bond with a 3% coupon | Approximate duration | If rates rise 1 point |
|---|---|---|
| 1-year bill or bond | 1 | −1% |
| 5-year note | 4.6 | −4.5% |
| 10-year note | 8.5 | −8% |
| 30-year bond | 19.6 | −17% |
That explains 2022: rates rose several points in a few months and long bonds lost more than many stocks. The benchmark US bond index (Bloomberg US Aggregate) lost 13%, its worst year on record. It works the other way too: when rates fall, long bonds rise the most.
If you own a bond fund or ETF, its fact sheet shows the portfolio’s average duration. It’s the most useful number to know how much it can move.
Credit risk: will you get your money back?
A creditworthy government borrowing in its own currency almost never fails to pay; a company can go bankrupt. Rating agencies (S&P, Moody’s, Fitch) grade each issuer:
| Rating | Category | What it means |
|---|---|---|
| AAA, AA | High investment grade | Very low risk of default |
| A, BBB | Investment grade | Low to moderate risk |
| BB, B | High yield (“junk”) | Noticeable risk: they pay more to compensate |
| CCC or lower | Speculative | High risk of default |
The difference between what a bond yields and what a Treasury of the same maturity yields is called the spread. When spreads blow out, the market smells trouble, and stocks usually feel it: US high-yield spreads jumped to around 20 percentage points in the 2008 crisis and above 10 points in March 2020.
The yield curve and what it signals
If you plot the yields of Treasuries at 3 months, 2, 5, 10 and 30 years, you get the yield curve:
- Normal (upward sloping). Lending for longer pays more. It’s the usual shape when the economy is doing well.
- Flat. Almost the same at every maturity: the market is unsure.
- Inverted (downward sloping). Short maturities pay more than long ones. The market expects rates to fall, usually because it sees the economy cooling.
In the US, the 2-year yield rising above the 10-year has come before almost every recession since the 1970s. It isn’t infallible: the curve was inverted from mid-2022 to 2024, the longest inversion in decades, without the expected recession arriving in that time. Use it as a thermometer, not a clock.
How to invest in bonds
| Way | How it works | Keep in mind |
|---|---|---|
| Directly | You buy Treasuries at auction through TreasuryDirect or a broker, from $100, or other bonds on the market through a broker | If you hold to maturity you know what you’ll get (barring default) |
| Bond mutual fund | A manager buys many bonds for you | It never matures: its value always moves with rates. Check its duration and fees |
| Bond ETF | Like a fund, but traded on the exchange | Low costs. It doesn’t mature either (except defined-maturity ETFs) |
| CDs and money market funds | Bank deposits for a fixed term, or funds holding very short-term debt | CDs are FDIC-insured up to the limits; money market funds aren’t, but invest in very safe assets |
We cover the differences between mutual funds and ETFs in ETFs, index funds and active funds.
Fixed income has five risks: interest rates (the price falls if they rise), credit (that they don’t pay), inflation (that what you receive loses value), currency (if the bond isn’t in dollars) and liquidity (that you can’t sell at a good price).
Why it matters even if you only own stocks
- It’s the benchmark. The Treasury yield is the minimum return demanded of any risky investment. If it rises, more is demanded of stocks.
- It competes with dividends. When a T-bill pays 4% with no risk, a utility paying 4% looks less attractive than when T-bills paid 0%.
- It sends signals. Spreads blowing out or an inverting curve warn of stress before it reaches stocks.
- A bond is a loan: you get a coupon and the face value back at maturity.
- Price and yield move in opposite directions; duration tells you how much the price falls if rates rise one point.
- Ratings measure the risk of default; the yield curve, what the market expects from the economy.
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General information for educational purposes. Not financial or tax advice, nor a recommendation to buy or sell securities. Investing in shares involves the risk of loss. · Contact: info@meridianscreener.com