Concept
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Now consider the lender’s perspective. An investor must decide whether to lend their money to some bond issuer, or to invest elsewhere, such as in an equity stake (in other words, an investor can buy bonds, or can buy other assets). Bonds are unusual assets in that their future values are known since the par value is to be paid at maturity is specified. This is unlike the majority of other assets, since the future value of a share or a house, for example, is not known in advance. It is important to note that we are overlooking the possibility of default for the moment.
The fixed future cash flows add some predictability to the bond investment but does not make it completely free of risk. The current price is not fixed and can change for better or worse. Variation of this nature means that bond investments exhibit market risk, or because prices are linked to interest rates, interest-rate risk. This idea is much more relevant when terms are long, and maturity is far away, since there is greater distance between the variable current price and the fixed maturity value (we will express this idea mathematically later on).
It is important to note that there is a possible confusion between a bond’s price (at a time before its maturity) and its par value (the value it pays at maturity). These are of course different quantities, but if someone states, “I will invest in a million dollars’ worth of bonds”, it is not clear
which quantity they are referring to. One meaning — probably the more conventional one amongst financial practitioners — is that they intend to purchase bonds with a par value of a million, which means that the value of the investment today will be less (possibly much less,
especially if interest rates are high and if there is a long time until maturity). But another reasonable interpretation is that they are investing a million today, which will purchase bonds with a par value larger than a million. You should be aware of this ambiguity, and, more generally, of the terminology we have introduced and how it is applied to a bond investment.