Understanding fixed income: Bonds

This article is part of a collaborative series by the CFA Society Sri Lanka, Securities and Exchange Commission of Sri Lanka (SEC) and the Colombo Stock Exchange (CSE) which aims to enhance financial literacy and empower individuals with the knowledge and tools to make informed financial decisions and build long-term financial security.

- by Keshawa Perera, CFA.

This week, we present the third article from our series: 'Understanding Fixed Income', authored by Keshawa Perera, CFA.

FIXED income investments, commonly known as Bonds, provide regular interest payments and return your original investment at the end of a fixed term. When you buy a Bond, you're lending money to a Government or company, and in return, you receive fixed interest payments (the “coupon”) and your principal at maturity. Bonds are valued for their stability and predictable income, making them a foundation for conservative investors and retirees seeking steady yet lower-risk returns.

How Bonds work:The basics

A Bond is a legal agreement between a borrower (issuer) and a lender (investor). The issuer promises to pay back the principal (face value) and make regular interest payments at a set rate (coupon rate) on specified dates (coupon dates) until the maturity date. Bonds are categorised by their maturity:

■ Short-term: Up to 3 years

■ Medium-term: 3-10 years

■ Long-term: Over 10 years

While Bonds pay fixed interest, their value can fluctuate in the secondary market, where Bonds are bought and sold after being issued. In the secondary Bond market, Bond prices and interest rates move in opposite directions. When interest rates fall, existing Bonds with higher fixed interest rates become more attractive to investors, so their prices go up. Conversely, when market interest rates rise, older Bonds offering lower interest rates become less valuable, causing their prices to drop. If you sell a Bond before maturity, you may receive more or less than you paid, depending on market interest rates. Accrued interest (the interest earned since the last payment), is added to the Bond's sale price.

What determines the interest rates on Bonds