Bond prices move opposite to yields because existing bonds with fixed coupons become less attractive when new bonds offer higher coupons, and vice versa. Duration measures a bond's sensitivity to interest-rate changes — the average time to receive cash flows, with longer duration meaning larger price swings for a given rate change. Convexity captures the curvature of the price-yield relationship: bonds gain more when rates fall significantly than they lose when rates rise by the same amount, which is a small additional benefit at the long end. Yield to maturity is the most meaningful comparison metric between bonds, because it accounts for price, coupon, and reinvestment, unlike current yield, which is simply annual coupon divided by price.
The yield curve plots yields for bonds of similar credit quality across different maturities and is normally upward-sloping, with longer maturities paying higher yields. An inverted yield curve, where short-term yields exceed long-term yields, has historically preceded recessions by 6-24 months and suggests the bond market expects future rate cuts. Credit ratings separate investment-grade bonds (AAA to BBB-) from high-yield or junk bonds (BB+ and below), with junk offering higher yields to compensate for higher default risk that averages around 4% long-term and spikes above 10% in recessions. Single junk bonds are dangerous; diversified junk bond funds handle the risk across hundreds of issuers.
Beyond standard bonds, several specialized instruments serve specific roles. Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds whose principal adjusts with CPI, useful for inflation-sensitive liabilities like retirement. I bonds are U.S. savings bonds with a two-part rate — a fixed rate set at issue plus a semi-annual inflation adjustment — and they are state-tax-free; the purchase cap is $10,000 per person per year. EE bonds are guaranteed to double in value if held 20 years, an effective minimum ~3.5% annual return. Municipal bonds offer federal-tax-exempt interest, often state-tax-exempt if held by residents of the issuing state; their tax-equivalent yield is calculated by dividing the muni yield by one minus the marginal tax rate — a 3.5% muni in a 32% bracket equates to a 5.15% taxable yield. Floating-rate bonds adjust coupons to a benchmark rate like SOFR, providing low duration and benefiting in rising-rate environments, though with higher credit risk.
For portfolio construction, bond funds offer instant diversification, automatic reinvestment, and easy rebalancing, while individual bonds give a known maturity value and eliminate mark-to-market volatility if held to maturity. A bond ladder — buying bonds maturing at staggered dates (1, 2, 3, 4, 5 years) and rolling the shortest maturity back to the long end — smooths interest-rate risk and produces predictable cash flows. TreasuryDirect lets you buy bills, notes, bonds, I bonds, and TIPS directly from the U.S. government with no fees, but is illiquid until maturity; for instant liquidity, short-duration Treasury ETFs like SGOV or BIL offer similar yield with brokerage trading. SGOV is state-tax-exempt and often beats a high-yield savings account in high-state-tax states, though a HYSA wins on FDIC insurance up to $250,000.