Can you answer this IB interview question?

What is a bond?

A bond is debt. The issuer borrows money and promises interest payments plus principal repayment; bondholders are creditors and sit ahead of equity holders in the capital structure.

Intuition

A bond turns a borrower's funding need into a standardized, tradable claim on a fixed set of future cash flows, so investors value it by discounting those promised payments at the return they require for time and credit risk. The issuer sells certainty of payment terms; investors buy that stream at a rate reflecting default risk, interest rates, and seniority. That is why price moves inversely with yield—when the market demands a higher return, the same contractual cash flows can only deliver it through a lower purchase price.

Watch

Be ready to distinguish a bond from a bank loan: bonds are tradable, governed by an indenture with looser covenants, usually bullet maturity, and callable at a premium—whereas loans are held by banks, have tighter covenants, and often amortize.

Deep Dive

Explain what a bond is in terms of its cash flow mechanics and how it functions as a financing instrument.

Core Mechanics:

At issuance, the investor pays the principal (face/par value, typically $$ 1, 000$ per bond) to the issuer.

Periodically (usually semi-annually), the issuer pays coupon payments:

Coupon Payment = Face Value \times \frac{Coupon Rate}{Periods per Year}

At maturity, the issuer repays the full face value.

Bond vs. Bank Loan:

Feature	Bond	Bank Loan
Lender	Public/institutional investors	Bank
Tradability	Trades in secondary market	Generally illiquid, sometimes syndicated
Documentation	Indenture (less restrictive covenants)	Credit agreement (tighter covenants)
Amortization	Typically bullet maturity	Often amortizing
Prepayment	Usually callable at premium or make-whole	Prepayable, sometimes small penalty

Price-Yield Relationship:

P = t = 1 \sum n \frac{C}{( 1 + y ) ^{t}} + \frac{Face Value}{( 1 + y ) ^{n}}

where $C$ = coupon payment, $y$ = yield per period, $n$ = number of periods.

If $y >$ coupon rate: trades at a discount (price < par)

If $y <$ coupon rate: trades at a premium (price > par)

If $y =$ coupon rate: trades at par

Shortcut: Bondholders rank above equity but typically below senior secured bank debt. Cost of debt from bonds feeds directly into WACC.