Week 5: Bonds — Coupons, Prices, and Yields

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1. Why This Is Important

A bond is the simplest financial instrument in the world. You lend someone a known amount, on a known schedule, for a known interest payment (the coupon — that's the bond-market word for it, and we'll use it for the rest of the lesson), and they pay you back at a known date. Four numbers and a calendar. Stocks have nothing this clean.

And yet — this simplest instrument generated the largest single multi-decade trend in modern financial history (a forty-year bull market from 1981 to 2020 in falling yields), and then in 2022 delivered the worst calendar year for US Treasuries on record. Both moves were already inside the four-number contract. §2.2 shows the one equation that turns the contract into a price; the rest of the lesson is just consequences of that equation.

*(Side note: that same present-value equation — future cash flows discounted back to today — is also how stocks, real estate, and every other cash-flow asset are valued. It is the most important formula in the entire course. We meet it cleanly here in bonds because bonds have the cleanest cash flows; we apply it to stocks in Week 21.)*

You need to understand bonds for five reasons.

They set the base of the discount rate for everything. Every

cash flow on earth — your mortgage (which is literally a bond you issued to the bank), a stock's earnings stream, a private-equity exit, a pension liability — is priced by discounting at the risk-free Treasury curve **plus an asset-specific risk premium**. The Treasury curve is the base; the premium is what the market demands on top for the particular asset's risk. When the 10-year yield moves from 1.5% to 4.5%, the base moves under every long-duration asset on the planet, and they all reprice (the spread on top can move too, but the base move is what nobody can hide from). You cannot understand any other asset class without understanding what its discount rate is doing. Worth knowing that bonds are also historically prior: organised sovereign debt markets predate organised stock markets by centuries (Sidney Homer's A History of Interest Rates traces continuous bond markets back to 13th-century Venice and Genoa; the Amsterdam stock exchange was a 1602 latecomer, and through most of the 18th and 19th centuries equities had a worse reputation than bonds — closer to gambling than investing). The modern instinct that "stocks are the main asset class and bonds are a sleepy add-on" is a 20th-century artefact, not a permanent truth.

They are an asset class in their own right. Last week's 60/40

leaned on Treasuries for the diversification benefit. This week we open the bond box and ask: what are we actually holding, how does it pay, and how does its price form? After this lesson the 40 in 60/40 is no longer a black box.

**The bond market is bigger than the stock market — and it is

what institutions actually trade.** Global bond market outstanding is roughly USD 130-140 trillion (BIS / SIFMA, 2024 estimates), against roughly USD 110 trillion in global equity market cap. US Treasuries alone are ~USD 27 trillion. Daily trading volume in US Treasuries runs ~USD 900 billion versus ~USD 500 billion across all US-listed stocks combined. Why does this matter to a retail equity investor? Because almost every form of leverage in the rest of the financial system is collateralised by Treasuries: bank reserves, repo (the overnight funding market that keeps brokers, hedge funds, and primary dealers running), futures-exchange margin, swap-dealer collateral, central-bank liquidity facilities. When Treasuries move, the cost and availability of leverage moves under every other asset. Stress in the Treasury market (e.g. March 2020, the September 2019 repo spike) is a stress signal for the whole system. Stocks are the visible tip; bonds are the plumbing underneath.

They tell you what the market expects. The yield curve, the

credit spread between BAA corporates and 10-year Treasuries, and the TIPS breakeven rate are three separate, daily-quoted, public forecasts of growth, default risk, and inflation. The bond market is the cheapest macro intelligence service on earth.

**The 1981-2020 bond bull market is the regime backdrop for

almost every "passive works" claim of the last two generations.** A generation of investors has never seen a real bond bear market — and 2022 was the first warning shot. This regime-shift framing is not original to this course: Howard Marks laid it out cleanly in his December 2022 Oaktree memo "Sea Change" (and again in the May 2023 follow-up), arguing that the four decades of falling rates from 1980 onward were a one-off tailwind for almost every asset and that we are now entering a higher-rate regime in which different strategies will work. Ray Dalio's *Principles for Dealing with the Changing World Order* (2021) makes the longer cycle argument; Lyn Alden's Broken Money (2023) makes the monetary-plumbing argument; Stanley Druckenmiller has been making the debt-and-deficit version of the same point in interviews since 2022. The point is that several serious investors with different lenses converged on the same call: the rate regime that made buy-and-hold look easy is over, or at minimum no longer the safe default. We will return to this throughout Levels 4 and 5.

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2. What You Need to Know

2.1 The Bond Cash Flow — Four Numbers and a Calendar

Scope of this lesson. Everything below is about *plain-vanilla fixed-rate bonds* — the contract is locked at issue and never changes. Callable bonds, floating-rate notes, TIPS, mortgage-backed securities, convertibles, and structured credit all add extra moving parts (issuer optionality, rate-resetting coupons, inflation-indexed principal, prepayment risk, equity-linked payoffs, tranching). We touch TIPS in §2.5 and §Q4, and credit/structured products get full treatment in Weeks 31-34. For this week, fix the picture of a coupon plus a balloon.

A bond is fully specified by:

• Face value $F$ — the amount returned at maturity. Almost

always $1,\!000 in the US market, conventionally quoted as 100.

• Coupon rate $c$ — the annual interest rate, fixed at issue.

A 4% coupon on a $1,\!000 face pays $40 per year.

• Years to maturity $N$ — when face is repaid.
• Payment frequency $m$ — how many coupon payments per year.

US Treasuries and corporates: $m = 2$ (semi-annual). Many international bonds: $m = 1$ (annual). Some municipals: $m = 4$.

Each coupon is $C = F \cdot c / m$. So a 4% semi-annual coupon on $1,\!000 face pays $20 every six months for $N$ years, plus $1,\!000 at the end.

That's it. That's the contract. Everything else — price, yield, duration, convexity — is *math performed on those four numbers plus a discount rate*.

2.2 Price Is Just Discounted Cash Flow

If you require an annual return of $y$ (the market yield, or yield to maturity) on the bond's risk profile, then the price you should be willing to pay today is the present value of every cash flow:

$$ P = \sum_{t=1}^{m \cdot N} \frac{C}{(1 + y/m)^{t}} + \frac{F}{(1 + y/m)^{m \cdot N}} $$

That sum has a closed form:

$$ P = C \cdot \frac{1 - (1 + y/m)^{-mN}}{y/m} + \frac{F}{(1 + y/m)^{mN}} $$

But the formula matters less than the shape: a bond is one geometric series of coupons plus one balloon payment of face. Drop either piece and you have a different instrument (the geometric series alone is an annuity; the balloon alone is a zero-coupon bond).

Three immediate consequences:

• If $y = c$, then $P = F$. The bond trades at par.
• If $y > c$, the cash flows aren't generous enough to give the

buyer the required return at face. The price must drop. Bond trades at a discount.

• If $y < c$, the buyer is happy to pay more than face for the

generous coupon. Bond trades at a premium.

The interactive panel later in this lesson lets you slide $c$, $y$, $N$, and $m$ live and watch $P$ recompute. Spend two minutes on it. Internalising the shape of the price-yield curve is worth more than memorising any formula.

2.3 Why Price and Yield Move Inversely

This is the single most asked-about feature of bonds, so be explicit. The cash flows are fixed at issue. Coupons are $C$ forever, face is $F$ forever. The only thing that changes day to day in the secondary market is the discount rate the market applies to those fixed cash flows. Higher discount rate -> lower present value -> lower price. Lower discount rate -> higher present value -> higher price.

The relationship is monotonic and convex. Monotonic: each $1 move in yield always moves price in the opposite direction. Convex: the price-yield curve bows toward the origin, which means **starting from the same yield, a 1% drop in yield raises price by more than a 1% rise of the same size lowers it**. (The two moves have to start from the same yield level and be the same absolute size; convexity is a local property of the curve, not a universal claim about any pair of yield moves.) That asymmetry is convexity, and for long bonds it is large. Watch it on the interactive: hold $c$, $N$ fixed, slide $y$ from 0% to 15% and see how the curve bends.

2.4 Duration — The "How Sensitive" Number

A 30-year bond and a 2-year bond do not respond equally to a 1% move in yield. Duration is the linear approximation of how much the price moves for a 1% yield change.

The Macaulay duration is the weighted average maturity of the cash flows, where each weight is the present value of that cash flow divided by the price:

$$ D_{\text{Mac}} = \frac{1}{P} \left[ \sum_{t=1}^{m N} \frac{(t/m) \cdot C}{(1 + y/m)^{t}} + \frac{N \cdot F}{(1 + y/m)^{m N}} \right] $$

The modified duration is the elasticity of price with respect to yield:

$$ D_{\text{mod}} = \frac{D_{\text{Mac}}}{1 + y/m} \quad \Rightarrow \quad \frac{\Delta P}{P} \approx -D_{\text{mod}} \cdot \Delta y $$

Rules of thumb worth memorising:

• 2-year Treasury: $D_{\text{mod}} \approx 1.9$. A 1% rate rise ->

~1.9% price drop.

• 10-year Treasury: $D_{\text{mod}} \approx 8.5$. A 1% rise ->

~8.5% price drop.

• 30-year Treasury: $D_{\text{mod}} \approx 19$. A 1% rise ->

~19% price drop.

In 2022, the 10-year yield rose from ~1.5% to ~3.9%, about 2.4%. Multiply by a duration of 8.5 and you get the realised -18% total return on the 10-year — almost exactly the loss we attributed to "bonds" in last week's 60/40 chart. The duration approximation is not a curiosity; it is the explanation. The deeper math (convexity adjustment, key-rate durations, OAS) waits for Week 32.

2.5 Yield to Maturity, Current Yield, and Coupon Rate

Three numbers that everyone confuses.

• Coupon rate: the contractual interest rate. Fixed at issue.

Never changes. Used for computing the dollar coupon.

• Current yield: $C \cdot m / P$. What the coupon stream alone

pays you, ignoring the pull-to-par on the principal. Useful for income-oriented buyers but incomplete as a return measure.

• Yield to maturity (YTM): the single discount rate $y$ that

makes the present value of all cash flows (coupons + face) equal to today's price. The internal rate of return on the bond. This is the headline yield you see quoted everywhere.

When a bond trades at par, all three are equal. When it trades at a discount, YTM > current yield > coupon rate (you get the coupon and a capital gain at maturity). When it trades at a premium, YTM < current yield < coupon rate.

Always compare bonds on YTM, not coupon. The coupon is a contract detail; the YTM is the return you actually earn only if you (a) hold to maturity and (b) reinvest every coupon at the same yield. Both conditions are usually violated. If you sell before maturity at a different yield, your realised return depends on where prices are that day — not on the YTM you bought at. If reinvestment rates fall (rise), your realised return ends up below (above) the original YTM. YTM is the bond's quoted internal rate of return; it is not a guaranteed realised return for a non-buy-and-hold investor.

Intuition check before you move on. A coupon is a number stamped on a contract — say "$40 a year forever until I pay back your $1,000" — and it never changes. A yield is the return a buyer demands today for taking on that contract. Those two numbers don't have to agree, because the price moves in between to make them agree. If demand is high, the price rises; the same $40-a-year stream now gives the buyer a lower percentage return on the higher purchase price; the yield drops. If demand collapses, the price falls; the same $40 now gives the buyer a higher percentage return; the yield rises. Coupon = contract; price = market; yield = the percentage return that falls out of the two. Open the interactive bond pricer below before you continue: hold the coupon at 4%, slide the market yield from 2% to 8%, and watch the price drop and the YTM climb. Two minutes on the slider is worth more than ten re-readings of this paragraph. This is the equation behind every asset valuation in the rest of the course — do not skip it.

2.6 Credit Ratings — and Why Not to Trust Them Blindly

Before we look at the spread between corporate bonds and Treasuries, you need to know what makes a corporate bond riskier in the first place — and how the market signals that.

When a company (or a country, or a city) issues a bond, third-party credit rating agencies assign it a letter grade from "basically as safe as Treasuries" down to "close to default." The big three are Moody's, S&P, and Fitch. Their scales differ slightly but map roughly to the same buckets:

Bucket	S&P / Fitch	Moody's	Plain English
Investment grade — highest	AAA	Aaa	Treasury-like (US gov was AAA until 2011)
Investment grade — high	AA / A	Aa / A	Strong company, low default risk
Investment grade — lowest	BBB+ to BBB-	Baa1 to Baa3	Adequate; "BBB" / "BAA" — the line we plot
Cutoff	---	---	Below this is no longer "investment grade"
Speculative / "junk"	BB+ down to CCC	Ba1 down to Caa	High yield; meaningful default risk
Default / near-default	CC, C, D	Ca, C	Restructuring or already missed a payment

The "BAA" you'll see on the chart in §2.7 is just Moody's spelling for the lowest investment-grade rung — the same place S&P writes "BBB". It is the cleanest century-long corporate series, which is why we use it.

The rating system has a structural conflict of interest. The rating agencies are paid by the issuer of the bond, not by the buyer. The company that wants its debt to look safer goes shopping for a rating, and the agency that gives it the higher grade gets the contract. This is the financial equivalent of letting students hire and pay their own examiners — and then asking the examiners to certify how smart the students are. This isn't a thought experiment. The historical record is brutal:

• Enron carried investment-grade ratings until four days

before it filed for the largest US bankruptcy at the time (December 2001).

• Lehman Brothers held an A-tier rating from all three

agencies on the morning it failed in September 2008.

• The 2008 housing crisis is the canonical case: tens of

thousands of subprime mortgage-backed securities were stamped AAA — the same rating as US Treasuries — and a large fraction of them went on to lose 60-100% of value. The Senate Permanent Subcommittee on Investigations (Levin-Coburn report, 2011) documented agencies rubber-stamping deals over their own analysts' objections to keep the issuer fees flowing.

• Greek sovereign debt was investment-grade until late 2009;

within months of the downgrade cascade, it was trading at 30 cents on the dollar.

What does this mean for a retail investor? **Treat ratings as a rough sort, not a verdict.** A AAA does not mean "safe"; it means "the issuer paid for that letter, and historically defaults in this bucket have been rare until they aren't." The market price and the daily yield spread (§2.7) tell you what *traders with their own money on the line* think — and they almost always move before the ratings do. A bond whose yield spread blows out to distressed levels while it still carries an investment-grade rating is the market telling you the rating is wrong; ignore the letter and read the spread.

2.7 Credit Spreads and the Realised Credit Premium

A US Treasury is the textbook default-free asset (it is as default-free as the dollar itself, which is a separate philosophical issue — see Week 31). Anything else is riskier. The market prices that extra risk by demanding a higher yield on the corporate bond than on the matched-maturity Treasury.

Two numbers, don't confuse them:

• Yield credit spread. A yield difference — for example

Moody's BAA corporate yield minus the 10-year Treasury yield, or the option-adjusted spread (OAS) on an investment-grade index. Quoted live, every day, in basis points. Widens upward when default risk reprices (Dec 2008 OAS hit ~600 bps; Mar 2020 hit ~400 bps; calm markets sit near 100-150 bps). This is the number traders mean when they say "spreads blew out."

• Realised excess return. The return on corporate debt

minus the return on Treasuries over the same holding period (e.g. annual). It bundles together what you earned from the starting yield spread and the price impact of any spread movement during the year. In a year where spreads blow out, this number goes sharply negative — corporate prices fall more than Treasury prices.

The chart below shows the second one — annual realised excess return of BAA corporates over the 10-year Treasury, from 1928 through 2024 (Damodaran annual series, BAA being the lowest investment-grade rating). It is the cleanest century-long proxy for what a retail buy-and-hold investor would have experienced holding corporates instead of Treasuries.

Three reads:

The long-run mean excess return is small and positive —

investment-grade corporate debt has earned roughly 1-2% per year above Treasuries on average. That is the unconditional realised credit premium.

The distribution has a fat left tail. In a credit blow-up

year (1932, 1974, 2008, 2020), corporates can underperform Treasuries by 10%-25% in a single year as default risk reprices (yield spreads blow out, corporate prices blow down) and Treasuries rally on the flight-to-safety bid.

**Yield spreads are an early-warning signal — but read them

live, not on this chart.* Daily/weekly OAS can* widen ahead of equity bottoms during a credit cycle. The annual realised excess-return chart above is too coarse to use as a leading indicator: it tells you a bad year happened, not that one is coming. For real-time monitoring, watch a daily yield-spread series (e.g. ICE BofA US Corporate OAS on FRED). The lesson from this chart is the long-run shape of the payoff, not timing.

For most retail investors the practical answer is: **the credit premium is real but small, and the tail risk is asymmetric**. Holding investment-grade corporate debt instead of Treasuries earns you maybe 1% extra in normal years and costs you 10%+ in the years that matter most. For diversification against equities, hold Treasuries. For yield-pickup income in retirement, a small allocation to investment-grade corporates is reasonable.

**Credit default swaps (CDS), capital structure, and the wider credit complex — short preview.** What we just covered is plain corporate debt — the borrower borrows, you lend, you collect. The wider credit complex includes a few more pieces you should at least recognise now and that we cover properly in Weeks 31-34:

• Capital structure (senior vs junior). A single company can

issue several layers of debt. Senior (or "secured") debt has the first claim on assets in bankruptcy and the lowest yield; junior / subordinated debt is paid only after senior is satisfied and yields more to compensate. Below that sits preferred equity, then common equity. Each layer is a different bond, with a different recovery rate when things break. Structured products like CMOs and CDOs slice the same underlying loan pool into tranches with the same stack — AAA tranches eat losses last, equity tranches first. The 2008 blow-up was largely a misrating of those tranches. (Week 33.)

• Bonds vs bank loans vs private credit. A bond is

publicly issued, traded in a secondary market, governed by an indenture, and rated. A bank loan ("leveraged loan") is a privately negotiated agreement, usually senior secured, floating-rate, and held by banks or loan-fund vehicles — it trades but more thinly. Private credit / direct lending is a non-bank loan from a fund directly to a company, often unrated and held to maturity. Same economic idea (someone borrows, someone lends), three different liquidity, disclosure, and pricing regimes.

• Credit default swaps (CDS). A CDS is insurance on a bond.

The buyer pays an annual premium (the CDS spread, in basis points); if the underlying bond defaults, the seller pays out. The CDS spread is the cleanest market-priced view of default risk on a given issuer. Sovereign-CDS markets in particular often move before the rating agencies act — Greek 5-year CDS was screaming distress for months while the official rating was still investment-grade. (Week 33 covers the mechanics; the retail takeaway here is that you can read CDS spreads as a free macro signal even though almost no retail investor trades them.)

2.8 The Forty-Year Bull Market and the 2022 Break

The chart below plots the 10-year US Treasury yield from 1962 through 2026, the longest clean monthly run we have on FRED's DGS10 series.

Three regimes you need to recognise.

• 1962-1981: yields rose. Inflation accelerated through the

Vietnam war, the Bretton Woods collapse, and two oil shocks. Bond returns over this period were poor in nominal terms and catastrophic in real terms — the worst sustained bond bear market of the 20th century. Holders of "safe" long Treasuries lost real wealth for two decades.

• **1981-2020: yields fell, in a near-uninterrupted forty-year

trend.** Volcker's 1981 rate peak broke inflation expectations, and every subsequent shock — 1987, 1990, 2000, 2008, 2020 — was met with lower terminal rates than the previous one. Bonds delivered roughly 7% nominal annualised returns over this stretch, the best forty-year run in their history.

• 2020-202?: yields rose again. The COVID liquidity flood, then

the 2022 inflation shock, ended the forty-year trend. The 10-year ran from 0.5% to 5% in 30 months. As of April 2026, the curve is near 4.2% and the market is debating whether we're in a 1980s- style normalisation or the start of a long secular grind higher. The argument for a higher floor: US federal debt is now ~120% of GDP, deficits are running ~6-7% of GDP in peacetime, and every year the Treasury has to roll over trillions of dollars of maturing debt at whatever the prevailing rate is (the *debt wall*; §2.10). When the supply of new bonds is enormous and growing, the marginal buyer demands a higher yield to absorb it — the Treasury cannot dictate the rate, it can only set the coupon and let the auction price tell it the true yield. Combine that with three sovereign-credit downgrades (S&P pulled US AAA in August 2011 to AA+; Fitch followed in August 2023; Moody's downgraded in May 2025), and "yields can only fall from here" stops being a safe assumption.

The regime-shift framing here is not original to this course. Howard Marks's December 2022 Oaktree memo "Sea Change" and the May 2023 follow-up "Sea Change II" lay out the argument that four decades of falling rates were a one-off tailwind under every asset class, and that the next decade will reward different behaviours. Ray Dalio's *Principles for Dealing with the Changing World Order* (2021) makes the longer cycle case; Lyn Alden's Broken Money (2023) makes the monetary-plumbing case; Stanley Druckenmiller has been hammering the debt-and-deficit version in interviews since 2022; David Rosenberg has the deflationist counter-argument. We are not picking a winner here — we are flagging that several serious investors with very different lenses converged on "the rate regime that made buy-and-hold look easy is over, or at minimum no longer the safe default." That passive index investing worked across 1981-2020 partly because bonds rallied and equity multiples expanded together as rates fell. The trigger that breaks the regime is **a sustained rise in long yields**, and we are watching that trigger fire right now in real time. It is too early to declare the regime over; it is too late to pretend nothing has changed.

2.9 TIPS, Floating-Rate Notes, and Bond Maturities You'll Meet

So far we have been looking at plain fixed-rate nominal bonds (face value and coupon both stated in dollars). The bond universe has a few common variants you'll bump into immediately as a retail investor; they all live on top of the same present-value equation, but with one or two pieces swapped out.

• TIPS (Treasury Inflation-Protected Securities). The

principal indexes to CPI. The coupon rate is fixed but applies to the inflation-adjusted principal, so dollar coupons grow with CPI too. The yield quoted on a TIPS is the real yield (above CPI). You're betting that realised inflation will exceed the breakeven inflation rate = nominal Treasury yield − TIPS real yield. (April 2026: ~4.2% − ~1.8% ≈ 2.4% on the 10-year.) Caveats: (a) the CPI those bonds index to is the official BLS CPI, which we already saw in Week 1 has been methodologically rebased multiple times since 1990 and is widely argued to under-state lived inflation — so even "inflation-protected" bonds are protected against the measured number, not necessarily your grocery bill; (b) when CPI prints high, the Fed often hikes nominal rates in response, which pushes TIPS prices down via duration even as the principal accrual pushes them up — the two effects partially cancel and TIPS can lose money in a rate-hiking inflation surprise (this happened in 2022); (c) **Canada discontinued new issuance of Real Return Bonds in November 2022** citing weak demand at auction, and that decision has been criticised by pension funds ever since — a useful reminder that even sovereign issuers can withdraw inflation protection from the menu. Historically the TIPS breakeven has been a roughly unbiased but noisy forecast of subsequent CPI: it tracks the long-run direction but routinely misses by 1-2 percentage points, and during liquidity stress (Q4 2008, March 2020) it temporarily collapses to absurd levels because TIPS are far less liquid than nominals.

• Floating-rate notes (FRNs). The coupon resets periodically

to a benchmark (SOFR + a fixed spread, or for many corporate FRNs, 3-month SOFR + 30-150 bps). When the benchmark moves, the coupon moves with it, so the price barely changes — duration is essentially the time to the next reset, which for a quarterly-reset note is ~0.25 years. FRNs are useful when you expect rates to rise (you keep collecting the higher coupons without taking the price hit) and useless when you expect them to fall (you give up the chance to lock in a higher fixed yield). The trade-off vs a vanilla nominal bond: you swap duration risk for reinvestment risk.

• Common bond maturities. Treasuries come in T-bills (4, 8,

13, 17, 26, 52 weeks; zero-coupon, sold at a discount to face), notes (2, 3, 5, 7, 10 year), and bonds (20, 30 year). Investment-grade corporates cluster heavily at 5, 10, 30 year. Perpetual bonds ("perps") have no maturity — the issuer pays the coupon forever and may call (redeem) the bond at par on specified dates; the UK consols issued in the 18th century were the canonical case (some ran for over 250 years before being redeemed in 2015). Century bonds (50- to 100-year maturities) are issued occasionally by sovereigns and blue-chip corporates — Disney issued a 100-year in 1993, Argentina issued a USD century bond in 2017 (and defaulted on it three years later, which tells you everything you need to know about reaching for yield on long-duration sovereign credit).

• Convertible bonds. A bond bundled with an embedded equity

call option — the holder can convert the bond into a fixed number of shares of the issuer's stock. They yield less than straight bonds because the equity option is worth something. Convertibles are their own asset class with their own Greeks-flavoured pricing math; we touch them when we cover options in Weeks 25-30 and again when we look at issuer capital-structure plays.

• Callable bonds. The issuer reserves the right to redeem the

bond early at a stated price. This is a short option *the buyer wrote to the issuer* — when rates fall, the issuer refinances cheaper and calls the old bond, capping your upside. Callable bonds therefore yield more than non-callable ones for the same credit/maturity. Most US Treasuries are non-callable; corporates and especially municipals are often callable — always check the indenture before you build a ladder.

2.10 The Debt Wall and the Refinancing Cycle

A bond is finite — every bond has a maturity date when the issuer has to hand back the principal. For an issuer with a steady stream of debt outstanding (every government, every large company, every mortgage holder), bonds are constantly maturing and have to be refinanced: the issuer comes back to market and sells new bonds to raise the cash to pay off the old ones. This recurring obligation is the refinancing cycle.

When you stack the maturities of all the bonds an issuer has outstanding by year, you get a wall — a year in which a large lump of debt is coming due all at once. Two examples to make this concrete:

• The US Treasury debt wall. Roughly USD 7-9 trillion of US

Treasury debt matures every year and has to be rolled at whatever the prevailing yield happens to be that day. When the Treasury issued a 10-year note at 0.7% in 2020, that note matures in 2030 and gets refinanced at whatever the 10-year yield is in 2030. If the 10-year is 4.5%, the federal interest bill rises mechanically and permanently — the Treasury cannot "choose" not to roll. As of 2026, US federal interest expense has crossed USD 1 trillion per year and now exceeds the entire defence budget. That is the refinancing cycle eating fiscal space in real time.

• The corporate "maturity wall." Roughly USD 1.8-2 trillion

of US investment-grade and high-yield corporate debt matures in the 2025-2027 window — most of it issued at 2-3% during the 2020-2021 zero-rate window. Companies that locked in cheap long-dated debt then are now refinancing at 5-7%. For a highly-levered firm whose interest coverage was already thin, a 300 bp jump in refi cost is the difference between comfortable and distressed. A wave of high-yield defaults in the next 24-36 months — if it comes — will be primarily a refinancing-cycle event, not a recession event.

The refinancing cycle is why "yields are higher than they used to be" is not a temporary bookkeeping fact — every year that passes, more of an issuer's old cheap debt rolls into new expensive debt, and the average coupon paid grinds higher toward the prevailing rate. For sovereigns this is the slow path to fiscal pressure; for corporates it is the slow path to credit repricing. Either way, it is bond plumbing — not a forecast, an accounting consequence — and worth watching.

2.11 How Retail Actually Buys Bonds (and Why ETFs Have Their Own Problem)

Almost no retail investor buys individual corporate bonds. Three reasons:

Liquidity is awful. Most corporate-bond CUSIPs trade a

handful of times a week, not a day. Bid/ask spreads are often 50-200 bps — you pay 1-2% just to get in and out. By contrast Treasuries are the most liquid asset on earth (tight bid/ask, $900b daily volume), and those you can comfortably buy individually.

Minimum lot sizes are large. Many corporate issues trade

in $5,000 or $10,000 minimums; a diversified 50-name corporate portfolio needs a quarter-million dollars before you can even start.

Single-issuer default risk is real. Lose 30% on one

bankrupt name and your whole bond sleeve takes a hit you can't diversify away with a small handful of issuers.

So retail typically holds a bond ETF (LQD, BND, AGG, HYG, etc.). That solves the three problems above but introduces one of its own that you should know about:

Most bond indices are weighted by amount of debt outstanding. Think about that. A market-cap-weighted stock index assigns the biggest weight to the company the market values most highly (Apple, Microsoft). A market-cap-weighted bond index assigns the biggest weight to the issuer that has borrowed the most. The most-indebted issuer is not necessarily the safest; it is literally the one with the most debt to repay. Aggregate bond ETFs end up overweight the US Treasury (which is fine — it is at least the borrower with printing-press authority) but also overweight the most-leveraged investment-grade corporates. This is structurally different from stock-index investing and is a reason "buy a corporate-bond ETF and forget it" is not as benign a default as "buy a stock-index ETF and forget it." If you want corporate exposure, look at equal-weighted or fundamentals-weighted bond ETFs, or accept the cap-weight bias deliberately.

This is also why a corporate-bond ETF in a credit blow-up does not behave like a Treasury ETF in a rate move: its top holdings are exactly the issuers most likely to be downgraded and repriced. The 2008 LQD drawdown (-15% peak-to-trough in late 2008) and the March 2020 HYG drawdown (-21% in three weeks) are the historical precedents.

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3. Common Misconceptions

Misconception 1: "Treasuries are riskless."

Treasuries are credit-riskless in nominal dollars (the US government can print the dollars it owes). They are not price-riskless or purchasing-power-riskless. In 2022 the 10-year lost 18% of its price. In 1973-1981 it lost roughly 40% of its real value. "No default risk" is not the same as "no risk."

A sharper version: even sovereigns can and do default on their own-currency debt. Russia in August 1998 defaulted on its domestic ruble-denominated GKO bonds because, although it could have printed rubles to pay, the cost (collapsing the FX peg, hyperinflation, banking-system implosion) was judged worse than the default. Argentina has serially defaulted on peso-denominated debt; Mexico's 1982 "tequila" crisis included a forced restructuring of dollar and peso obligations. "Print to pay" is a political choice, not a mathematical guarantee. The US specifically has its **AAA stripped three times**: S&P in August 2011 (debt-ceiling brinksmanship), Fitch in August 2023 ("erosion of governance"), Moody's in May 2025 (rising debt burden and persistent fiscal deficits). Treasuries are still the deepest, most-liquid sovereign bond on earth and still the global reserve collateral asset — but "riskless" was a 20th-century shorthand that no longer survives literal inspection. Default by inflation is the more realistic scenario for any sovereign with debt in its own currency: pay back the nominal dollars, just dollars worth less.

Misconception 2: "If I hold to maturity, I can't lose."

In nominal terms, yes — you get face plus coupons back. But the real value of those payments depends on inflation between purchase and maturity. A 30-year bond bought at 2% in 2020 is contractually locked in to deliver a real loss if inflation averages 3% over the holding period. Holding to maturity protects you from price volatility, not from inflation. (We come back to where the price volatility comes from — duration and yield-curve moves — properly in Week 31 on the yield curve and Week 32 on duration & convexity. For Level 1 the rule of thumb in §2.4 is enough: longer maturity = more price swing per 1% yield move.)

**Misconception 3: "Bond funds just hold bonds — they should behave the same as holding the bonds directly."**

A bond fund maintains a roughly constant duration by selling old bonds and buying new ones. An individual bond's duration *falls mechanically* as it approaches maturity. So a fund that targets 20-year duration is, in a rising-rate environment, the structurally worst possible thing to hold — exactly what TLT investors learned in

If you have a specific liability date, hold individual bonds

matched to that date; a fund is not equivalent.

Misconception 4: "Higher coupon means higher yield."

The coupon is the contract; the yield is the market price. A 10% coupon bond can have a 3% yield (it's trading at a huge premium) and a 1% coupon bond can have a 6% yield (it's at a deep discount). Always compare on YTM, not coupon.

**Misconception 5: "Credit spreads are just extra yield — free income."**

The historical credit premium is 1%-2% in the average year and -10%-or-worse in the years that matter (1932, 1974, 2008, 2020). When you buy a corporate bond instead of a Treasury, you are not just collecting "a bit of extra yield" — you are *taking on the risk that the company defaults*, and the extra yield (the credit spread) is the market's price for that risk. Functionally, that makes the corporate-bond holder the seller of default insurance to the company: the company pays you the extra yield each year (the "insurance premium"), and in exchange, if the company goes bust, you eat some of the loss (the "insurance payout"). It is the same risk pattern an insurance company sees on a fire policy: lots of small premiums collected, and once in a while a house burns down and they pay out a big claim.

That shape of payoff — small wins most of the time, occasional large losses — is what "negatively skewed" means in plain language. Picture the distribution of annual returns: it has a short fat right side ("normal year, +1.5% extra") and a long thin left tail ("crisis year, -15%"). The average return is positive, but most of the bad-year losses are bigger than any single good-year gain. So selling credit insurance is not free yield; it is paid risk-taking, and the years where it costs you are exactly the years your equity sleeve is also down. That's why the diversification job in 60/40 belongs to Treasuries, not corporates.

**Misconception 6: "Long bonds have higher yields, so they're better."**

Longer maturity earns the term premium — but with much higher duration risk. The Sharpe ratio of long Treasuries is comparable to or worse than that of intermediate Treasuries over most historical windows. Reach for the term premium only if you have a specific liability that matches that maturity, or you are explicitly making a duration bet (deliberately overweighting long bonds because you think yields will fall, which would push long-bond prices up sharply via their high duration; the inverse bet is to avoid long bonds because you think yields are heading higher — the 2020 "buy TLT" investor discovered the wrong side of this in 2022). And note: "just roll short bonds into long bonds" sounds free but isn't. When the yield curve is inverted (short yields > long yields), as it was for most of 2022-2024, rolling short into long actually gives up yield. We cover the curve shape and the term-premium story properly in Week 31.

**Misconception 7: "Inflation-protected bonds (TIPS) are always better than nominal bonds."**

TIPS are better when inflation surprises upward relative to the breakeven rate priced into them. They are worse when inflation surprises downward, or when the breakeven is expensive. TIPS are a relative trade against nominal Treasuries, not a free upgrade. Two extra points worth absorbing: (i) TIPS index to official CPI — so they protect against the CPI methodology used by the BLS, not necessarily against the actual cost-of-living change you feel (recall the Week 1 ShadowStats discussion); (ii) when CPI prints high and the Fed responds by hiking rates, TIPS take duration losses that partially or fully offset the inflation-accrual gains — TIPS lost money in 2022 even though inflation was at multi-decade highs, because the rate-hike response drove their real yields up sharply. (§2.9 covers the mechanics; §Q4 walks the breakeven calculation.)

**Misconception 8: "Negative-yield bonds make no sense and no one should buy them."**

European and Japanese institutional investors held trillions of dollars in negative-yielding bonds during 2014-2021. Some of that demand was voluntary (price upside if rates went more negative; FX-hedged carry that was positive once you hedged dollars back to euros), but a meaningful chunk was effectively forced: bank, insurance, and pension regulation in the EU (Solvency II for insurers, Basel III LCR for banks) requires institutions to hold a minimum amount of high-quality liquid assets — which in practice means sovereign bonds — regardless of the yield, and liability-matching pension funds discounting at long real rates are obliged to hold matched-duration bonds even at negative yields. So "it makes no sense for me as a retail investor" is correct (you can just hold cash); "it makes no sense for anyone" is wrong. Notice the asymmetry: regulated institutions can be compelled into a trade you can walk away from — one of the structural retail advantages we'll come back to in later levels.

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4. Q&A Section

Q1: I want monthly income from bonds. What's the cleanest way?

A: Build a bond ladder — buy individual Treasuries or TIPS maturing in each of the next 5-10 years, equal-weighted. Each year one rung matures and you reinvest at the then-current yield. Cash flow is roughly the average yield × portfolio value. Avoids fund duration drift and gives you a predictable schedule. The brokerage tools at Fidelity, Schwab, and Vanguard let you click through the mechanics in 15 minutes — but before you place orders, check each line: bid/ask spread (corporates can be wide; Treasuries are tight), callable status (a callable bond is not a true ladder rung — the issuer can take it back early), the exact maturity date (line up with when you actually need the cash), tax treatment (Treasury interest is state-tax-exempt; munis are federal-tax-exempt; corporates are fully taxable), and minimum lot size (some bonds trade in $5,000 or $10,000 minimums that won't fit a small ladder evenly).

Q2: Should I buy individual bonds or bond ETFs?

A: Treat Treasuries and corporates differently.

• Treasuries. Modern brokers (Fidelity, Schwab, Vanguard,

Interactive Brokers, plus TreasuryDirect) make individual T-bills, notes, and bonds cheap and liquid even for small accounts — bid/ask is tight and there are no fund expense ratios. For a buy-and-hold ladder you can comfortably go individual at any account size.

• Corporates. Individual corporate bonds have wide bid/ask

spreads, thin secondary-market liquidity, and meaningful single-issuer default risk. For retail accounts of essentially any size, an ETF (LQD investment-grade, HYG/JNK high-yield) is the better tool.

• Bond funds in general. ETFs (BND, AGG, IEF, TLT, SHY) buy

you instant diversification and a constant-duration sleeve. The cost is the duration-drift problem from Misconception 3: the fund never matures, so you can't "hold to maturity" your way out of a price drawdown. For a specific future cash need, match an individual Treasury to the date.

Q3: What's the right bond duration for me?

A: Roughly match your investment horizon. 1-3 year Treasuries (SHY) for money you need within five years. Intermediate (IEF, ~7 yr) for the diversifier sleeve in a 60/40-style portfolio. Long bonds (TLT, ~20 yr) only as a deliberate duration bet — buying long bonds because you expect yields to fall and want the high-duration price gain that produces, not as a sleepy default. The 2022 lesson: duration is a loaded dimension; don't accidentally take more than you intended.

Q4: How is a TIPS different from a regular Treasury?

A: A TIPS' principal adjusts upward with CPI. The coupon rate is fixed but applies to the inflation-adjusted principal, so dollar coupons grow with inflation too. The "real yield" you see quoted on TIPS is the yield above CPI. The breakeven inflation rate is the difference between the nominal Treasury yield and the TIPS real yield at the same maturity — if realised CPI over the holding period exceeds breakeven, TIPS win; if it falls short, nominals win. (April 2026: 10-year nominal ~4.2%, 10-year TIPS real ~1.8%, so 10-year breakeven ~2.4%. TIPS win the next decade if average official CPI is above 2.4%.)

Three honest caveats. First, the CPI those bonds index to is the same official BLS series we picked apart in Week 1 — hedonic adjustments, geometric-mean weighting, owner-equivalent rent — so TIPS protect against the measured number, not necessarily your grocery bill. Second, when CPI rises and the Fed hikes rates in response, TIPS take duration losses that partially offset the inflation-accrual gains, which is exactly why TIPS lost money in 2022 even with inflation at multi-decade highs. Third, historically the breakeven has been a **roughly unbiased but noisy** forecast of subsequent CPI: it tracks the long-run direction but routinely misses by 1-2 percentage points, and during liquidity stress (Q4 2008, March 2020) the breakeven temporarily collapses to absurd levels because TIPS are far thinner than nominals. Treat the breakeven as the market's *best central estimate*, not as a precise forecast.

Q5: Why did the long bond fall 30% in 2022 when "bonds are safe"?

A: Long-bond duration is roughly 19. Yields went from ~1.5% to ~4%. Multiply: 19 × 2.5% ≈ 47% expected price drop, partially offset by coupon income, netting to the realised -30% range. "Bonds are safe" is shorthand for "low credit risk", not "low price volatility." Long bonds have equity-like price volatility when rates move sharply.

Q6: What's the yield curve and why do people obsess over it?

A: The yield curve is yields plotted against maturity (3-month, 1-year, 5-year, 10-year, 30-year). Normally upward-sloping (longer = higher yield). When the 2-year exceeds the 10-year — the inverted curve — it has historically been one of the most reliable recession leading indicators, with a 12-24 month lead. The inversion warning fired before each of the 1990, 2001, 2008, and 2020 recessions; it also pre-dates the early-1980s Volcker recessions. The most famous recent precedent is the inverted curve from mid-2006 through mid-2007, with the recession landing late-2007.

As of April 2026 (this paragraph will age), the curve has just un-inverted after a record-long inversion that began in mid-

Historically the recession often arrives after the

un-inversion, not during the inversion itself, so "the curve is back to normal" is not an all-clear. Whether the post-inversion recession is off the table or merely delayed is the live debate; by the time you read this, the answer may already be in.

This is genuinely the most-traded "signal" in fixed income, and Level 1 only scratches the surface. Week 31 does the full yield-curve lesson — level / slope / curvature, what each shape is telling you, why segments of the curve trade differently, and how to read the curve in real time. For now: know the shape, know that an inversion is the warning, and use the Week 10 economic-cycles dashboard for the live read.

Q7: What is "convexity" in one sentence?

A: The bend in the price-yield curve — the higher-order term that makes price gains from falling rates larger than price losses from the same-size rising rates. Long bonds and zero-coupon bonds have the most convexity. It's a free option that gets paid for via slightly lower yield. Week 32 unpacks it formally.

Q8: Are corporate bonds a substitute for Treasuries in 60/40?

A: No. Corporate bonds have meaningful equity-correlation in crises (the realised-excess-return chart in §2.7 makes this concrete) and so they don't deliver the negative correlation that Treasuries give you in a flight-to-safety event. If you want yield, take it on the equity side; keep the bond sleeve in Treasuries for the diversification job.

Q9: How much of my portfolio should be bonds?

A: Outside of the 60/40 baseline (Week 4), the barbell shape holds less bonds than 60/40, more in cash + short Treasuries on the safe side, and more in equity tail bets on the asymmetric side. A 30-year-old building wealth probably runs 20-30% in short Treasuries; a 65-year-old in distribution probably runs 40-50%. The exact number is less important than understanding what role bonds play (price stability + recession hedge) and sizing accordingly.

Q10: What about high-yield ("junk") bonds?

A: High yield is a third asset class. Correlated more to equities than to Treasuries (about 0.7 to S&P 500). Sharpe ratio over the full cycle is mediocre. Default rates spike in recessions. A small allocation can be defensible for income-focused retirees but it should never replace your Treasury sleeve — it doesn't do the diversification job that Treasuries do.

Q11: Where does this lesson connect to the rest of the course?

A: Week 4 used Treasuries as a black box; this week opens the box. Week 15 (multi-asset / four-tranche / the barbell shape) chooses short Treasuries over long for the safe sleeve based on §2.4 — you take the rate-cut diversification benefit without absorbing 20-year duration shocks like 2022. Week 18 covers Fed-vs-market interest rates and how they cascade into asset prices. Week 31 is the full yield-curve lesson (level, slope, curvature, inversion mechanics in detail). Week 32 is the rigorous duration and convexity math (key-rate durations, convexity adjustment, OAS). Week 33 is the credit lesson (rating mechanics, IG vs HY, structured-credit tranching, CDS). Week 34 is rate-sensitivity across asset classes (the 2022 case study end-to-end). Week 47 and 50 cover long-volatility / managed-futures overlays that hedge the inflation tail that bonds can't.

The interactive panel below lets you slide the four-number bond contract (face, coupon, maturity, payment frequency) and the market yield, and watch the price recompute live. The chart shows the price-yield curve from 0% to 15% with your current point marked. Watch the curvature change as you increase maturity — the 30-year line is dramatically more convex than the 2-year. Macaulay and modified duration are reported below the chart.

*If you are reading this on a device or in a context where the interactive panel can't render, the static chart below shows the same relationship for representative 2-year, 10-year, and 30-year bonds at a 4% coupon — longer maturity is a steeper, more bowed curve, which is duration and convexity made visible.*