What fixed income really is
Fixed income is the market for lending money at agreed terms. You hand over cash today and receive a schedule of payments back. A plain bond is the clearest example. You buy a bond with a face value of 1,000, it pays a 5% coupon once a year, and it matures in five years. Each year you collect 50. At the end you get your 1,000 back plus the last coupon. Nothing mysterious, just a loan with a receipt that can be traded.
The catch is price. Once a bond exists, its price moves in the market while its coupon stays fixed. If rates for new bonds rise to 7%, nobody wants your 5% bond at full price, so its price falls until the return matches. This is the single most important fact in the whole subject: bond prices and yields move in opposite directions. When yields go up, prices go down, and the reverse holds too.
Yield is just the return you actually earn given the price you pay. Buy that same 5% bond for 950 instead of 1,000 and your yield is higher than 5%, because you still collect the fixed 50 coupons and also pocket the 50 gain at maturity. Learning to feel that relationship, price in one hand and yield in the other, is most of the battle.
Duration and why long bonds swing harder
Two bonds can both yield 5% and still behave very differently when rates move. A bond that matures next year barely reacts. A 30-year bond can lose serious value from the same rate change. Duration is the number that captures this sensitivity. Think of it as the approximate percentage price change for a 1% shift in yield.
A worked feel for it: a bond with a duration of 7 will fall roughly 7% in price if yields rise by 1%, and rise about 7% if yields drop by 1%. That is why a portfolio manager who expects rates to climb will shorten duration, holding bonds that mature sooner, and someone betting on falling rates will stretch duration to capture more of the move. Duration is not maturity, though longer maturity usually means longer duration. Bigger coupons pull it down, because more of your money comes back sooner.
Repos: the overnight plumbing
A repo, short for repurchase agreement, is a loan dressed up as a sale. One party sells a bond today and promises to buy it back tomorrow at a slightly higher price. The bond acts as collateral, the price difference acts as interest. If I sell you a 10 million Treasury and agree to repurchase it the next day for 10,000,411, that small gap is your overnight interest at the repo rate.
This market is huge and mostly invisible to outsiders, yet it funds a large share of bond trading. Dealers use repos to finance the bonds they hold, and cash-rich institutions use the reverse side to earn a safe overnight return against solid collateral. When repo rates spike, as they did in September 2019, it is a signal that cash has grown scarce in the system. For a learner, the useful idea is simple: repos turn a bond you own into short-term cash without truly selling it.
Swaps and FRAs: trading fixed for floating
An interest-rate swap is an agreement to exchange two streams of interest on the same notional amount. Usually one side pays a fixed rate and the other pays a floating rate that resets periodically. The notional itself never changes hands, only the interest difference does. Picture a company with a floating-rate loan that fears rising rates. It enters a swap to pay fixed and receive floating. Now the floating leg it receives cancels the floating loan it owes, and it is left paying a clean fixed rate. It has converted uncertainty into a known cost.
A forward rate agreement, or FRA, is the small cousin of the swap. It locks in an interest rate for a single future period rather than a whole series. You might agree today on the three-month rate that will apply starting in six months. If the actual rate lands higher, one side pays the other the difference. A swap is essentially a chain of these forward agreements bundled together into one contract.
Pricing intuition here is worth grasping early. The fixed rate on a fair swap is set so that, at the start, neither side owes the other anything. It is the rate that makes the expected fixed payments equal the expected floating payments given today's forward curve. As rates move afterward, the swap gains value for one side and loses it for the other.
Options on rates: swaptions, caps and floors
Sometimes you want protection without commitment. That is where options on interest rates come in. A cap pays you whenever a floating rate rises above an agreed strike. A borrower who pays floating can buy a cap at 6%, and if the rate ever exceeds 6%, the cap covers the excess. The borrower keeps the benefit of low rates and buys away the pain of high ones, in exchange for a premium paid up front. A floor is the mirror image, paying out when rates fall below a strike, which suits a lender who wants a minimum return.
A swaption is an option to enter a swap. Buy a payer swaption and you gain the right, but not the obligation, to start paying fixed on a swap at a set rate on a future date. If rates have climbed by then, you exercise and lock in the old cheaper fixed rate. If rates fell, you let it expire and simply swap at market. You pay a premium for that flexibility. Caps and floors are really strings of small options on single periods, while a swaption is one option over an entire swap.
Credit default swaps and pricing intuition
So far the risk has been about rates moving. Credit adds a second worry: the borrower might not pay at all. A credit default swap, or CDS, is insurance against exactly that. The buyer pays a regular premium, often quoted in basis points per year, and if the named borrower defaults, the seller compensates the buyer for the loss. Protection on a company at 200 basis points means paying 2% of the insured amount each year to be covered.
The premium tracks perceived risk. A rock-solid government trades at a handful of basis points. A shaky company can trade at several hundred or more, and a spread that suddenly widens is the market shouting that default looks more likely. During 2008, CDS spreads on some banks blew out well before the news made headlines.
Pull the pieces together and pricing across fixed income rests on a few honest questions. What are the future cash flows? When do they arrive, since money sooner is worth more than money later? And how likely am I to actually receive them? Discount those cash flows back to today, adjust for the chance of default, and you have a value. This content is educational only and is not investment advice. Treat every worked number here as a way to build intuition, then check real prices and real terms before drawing any conclusion.