Bonds: what they are, how they pay and why their price changes

A bond is a written promise. Whoever buys one hands a sum of money to someone, the issuer, who commits to paying it back on a set date, the maturity, and often to paying interest along the way. The issuer can be a national government, a bank, a company or a supranational body; what they all want is funding. The amount that will be repaid is called the face value.

What sets a bond apart from a loan between friends is that the promise is a security: it can be sold to someone else before it matures. Almost everything that makes bonds less simple than they look starts there, beginning with a price that moves. Italy’s government bonds (BOT, BTP and their relatives) serve as the worked example throughout, but the basic mechanics apply to bonds in general.

A loan with many lenders

Borrowing money from the public is an idea with a few centuries behind it. In 1694 King William III of England needed funds for the war against France, and the Scottish merchant William Paterson proposed having ordinary people lend the money directly: £1.2 million, at 8% interest. According to the Bank of England Museum, the sum was raised in 11 days by 1,268 people, and on 27 July that year the Bank of England itself was founded. Trust was not a given: in 1672 Charles II had failed to repay the loans he received from goldsmiths.

The underlying mechanism hasn’t changed. Borsa Italiana, the Italian stock exchange, defines bonds as securities representing a loan issued by a private company or a public body to raise part of the money it needs. When the borrower is a government, those securities become part of its public debt.

Owner or lender: stocks and bonds compared

This is the distinction worth pinning down first. Buying stock makes you a part-owner of a company. Buying a bond makes you its creditor. Consob, Italy’s financial markets regulator, points out that a bondholder’s right to be repaid can be delayed or placed behind other creditors, but not taken away.

	Stocks	Bonds
The holder is	A part-owner (shareholder)	A creditor
Main right	Taking part in the company as a shareholder	Repayment of the face value at maturity
Risk	Usually higher	Usually lower, never zero
In a bank crisis (bail-in)	Absorb losses first	Absorb losses after shareholders

Corporate bondholders aren’t left on their own, either. Under the Italian rules Consob describes, they can gather in a bondholders’ meeting, which can change the terms of the loan by majority vote, and they have a common representative whose job is to protect their interests in dealings with the company.

The coupon and the real return

The interest the issuer pays at regular intervals is called the coupon, and its percentage of the face value is the coupon rate. An Italian BTP, for instance, pays a fixed annual coupon split into two six-monthly installments. Consob describes interest as the price an investor demands for lending money, and coupons can follow different rules:

• fixed-rate, with amounts set from the start;
• floating-rate, tied to market interest rates;
• inflation-linked, where the coupon (and often the repayment) grows when prices rise;
• zero-coupon, with no coupon at all: the only gain is the difference between purchase price and repayment.

The coupon alone doesn’t tell you how much you earn, though. The yield to maturity, meaning the return for someone who holds the bond to the end, combines the coupons with the gap between the repayment value and the price paid, known as the discount when the bond was bought for less.

Practical example: a BOT, an Italian short-term Treasury bill, with a face value of €100 is bought for €97. It pays no coupon, but at maturity it returns €100: that €3 discount is the whole gain.

A bond’s price rarely matches its face value. The Bank of Italy gives the example of BTPs with a face value of €1,000 bought for €923 or for €1,015. In market jargon a bond trades below par when it costs less than face value and above par when it costs more; BOTs and BTPs are repaid at par. Buying below par adds a gain on top of the coupons. Buying above par gives part of it back, and the yield to maturity ends up lower than the coupon.

Why bond prices fall when interest rates rise

Here is the part that confuses people most. Bond prices and market interest rates move in opposite directions, and the reason is concrete. The coupon on a fixed-rate bond is written into the contract and doesn’t change. If similar bonds paying more come out in the meantime, nobody will buy the old one at the same price. To compete, it has to get cheaper.

Practical example: you paid €100 for a bond paying 4% a year, that is €4. Then rates rise and similar new bonds pay 6%, or €6. Your bond now earns less than the others, and if you want to sell it you’ll have to accept a lower price.

The SEC, the US securities regulator, runs the numbers on a $1,000 bond with a 3% coupon and a ten-year maturity. If market rates climb to 4% a year later, the price falls to $925 and the yield to maturity for a buyer rises to 4%. If rates drop to 2% instead, the price rises to $1,082 and the yield to maturity falls to 2%.

Market rates after one year	Bond price	Yield to maturity
Unchanged at 3%	$1,000 (at par)	3%
Up to 4%	$925 (below par)	4%
Down to 2%	$1,082 (above par)	2%

The effect isn’t the same for every bond. It is generally stronger when the maturity is far away and when the coupon is low. To measure it, investors use duration. As a rule of thumb, FINRA explains, for every percentage point that rates move, a bond’s price moves the opposite way by a percentage equal to its duration. A bond with a duration of 10 loses about 10% if rates rise by one point.

Anyone who holds the bond to maturity, the SEC notes, still receives the promised coupons and the face value, whatever happened to the price along the way.

Not all bonds are alike

Beyond the type of coupon, what matters is how long a bond lasts and where it stands in the line of creditors. The Bank of Italy calls bonds that mature within one or two years short-term, and those lasting five or ten years or more long-term.

• Ordinary bonds, also called senior bonds, are repaid before subordinated (or junior) bonds if the issuer runs into trouble. From the same issuer, subordinated bonds are therefore riskier.
• Convertible bonds give their holders the option of turning them into shares of the company.
• Structured bonds contain a derivative contract: their return depends on other variables, such as stock indices, exchange rates or commodities. Consob describes them as more complex and harder to understand.

The risks, one by one

The Bank of Italy writes that bonds are normally less risky than stocks. “Less” is the word to keep in mind. These are the main risks:

Risk	What it means	Who it hits hardest
Interest rate	The price falls if market rates rise	Fixed-rate bonds with a distant maturity
Credit	The issuer fails to pay interest or capital, in full or in part	Issuers whose finances are getting worse
Liquidity	It’s hard to sell quickly and at a good price before maturity	Bonds that rarely trade
Currency	The value shifts with the exchange rate	Bonds in a currency other than the one you earn and spend, such as dollars instead of euros
Inflation	The coupons buy less	Bonds whose coupon is lower than the rise in prices
Early redemption	The issuer repays early, usually when rates are falling	Bonds that allow it

Inflation risk is easy to see with FINRA’s numbers: if a bond pays 5% and prices rise by 8%, the purchasing power of the interest shrinks. The Recap on inflation walks through how that works.

Credit risk has a textbook Italian case too. Bonds linked to Parmalat, the Bank of Italy recalls, were repaid only in part, and the people who had put their savings into them lost money. The Bank of Italy also warns that concentrating your money in bonds from a single issuer is very risky.

For banks there is also the bail-in, introduced by the European Union in 2014 and in force in Italy since 1 January 2016. If a bank fails, losses fall in this order: shareholders, holders of subordinated bonds, holders of unsecured ordinary bonds and finally deposits above €100,000. Those left out include deposits up to €100,000 and secured bonds.

Credit ratings and spreads

To gauge how reliable an issuer is, there are credit rating agencies. They grade issuers on a scale that runs from AAA, the highest reliability, down to D, which signals default. Bonds rated from AAA to BBB- are called investment grade; below BBB- they are speculative, or junk. The lower the rating, the more a lender demands in return for the risk.

The spread measures exactly that difference: it’s the gap between the yields to maturity of bonds from two different issuers. In Italy the usual comparison is the ten-year BTP against its German equivalent, the Bund.

Practical example: according to the Bank of Italy, on 29 December 2025 the ten-year BTP yielded about 3.5% and the German Bund about 2.8%. The spread was therefore 0.7 percentage points, or 70 basis points.

Italian government bonds

When the issuer is a national government, the bond is called a government bond. In Italy they are issued by the Treasury Department of the Ministry of Economy and Finance (MEF), with a minimum denomination of €1,000 face value.

Bond	Maturity	How it pays
BOT (Buoni ordinari del Tesoro, Treasury bills)	3, 6 or 12 months	No coupon, only the issue discount
BTP Short Term	Between 18 and 30 months	Like BTPs, a fixed coupon
BTP (Buoni del Tesoro poliennali, multi-year Treasury bonds)	From 18 months to 50 years	Fixed coupon paid every six months
CCTeu	Medium term, between 3 and 7 years according to the Bank of Italy	Floating coupon tied to Euribor
BTP Italia	Varies by issue	Payments linked to Italian inflation
BTP€i	Varies by issue	Payments linked to euro area inflation

Anyone who comes across CTZs (Certificati del Tesoro zero coupon, zero-coupon Treasury certificates) in textbooks should know they are no longer issued. The Ministry suspended them from the auction of 25 March 2021, when the BTP Short Term made its debut, designed to make the short-term segment more efficient.

Taxes differ as well. As of September 2026, the Bank of Italy states that returns on Italian government bonds are taxed in Italy at 12.5%, against 26% for other bonds.

Where to buy bonds: primary and secondary markets

A bond can be bought at two moments. The primary market is the issue, when the bond is offered for the first time. For Italian government bonds this normally happens through an auction, which savers join through an intermediary such as a bank. The rules depend on the bond. BOT auctions are competitive: bids are made in terms of yield, and each accepted bid is allotted at the rate it offered. For medium- and long-term bonds the auction is a marginal (uniform-price) one, where every accepted bid pays the same price. Settlement takes place two business days after the auction.

The secondary market covers every later trade between investors. In Italy it includes the MOT, run by Borsa Italiana; MTS, on the other hand, is reserved for authorized intermediaries, with a minimum trade of €2 million.

Practical example: Giulia buys a BTP at auction, on the primary market. Three years later she sells it on the MOT to Luca, who buys it on the secondary market at that day’s price. From then on, the coupons and the final repayment belong to Luca.