In simple terms, a bond is a piece of paper that pays a dollar amount per year to the holder for N number of years, after which the initial price paid for the b

In simple terms, a bond is a piece of paper that pays a dollar amount per year to the holder for N number of years, after which the initial price paid for the bond is returned to the holder. For example, a 10-year bond that pays $2 per year costs $100 today. That is, a piece of paper that pays $2 to the holder every year for 10 years, after which the holder gets its $100 back. Now, some time passes and the market thinks the above bond is too expensive. Instead, the market will only pay $50 for the above bond, ie. $50 to get $2 per year. This means that the price of another bond: the bond that pays $4 per year will now cost $100. This is the case because holding two bonds that cost $50 each and pay $2 per year is exactly equivalent to holding a single bond that pays $4 per year and costs $100. If the market price of a 10-year bond that pays $4 per year costs $100 then we say that the current rate of interest for the 10-year bond is 4%. If this rate of interest falls to 2%, it simply means that the market is now willing to pay $200 per year for a bond that pays $4 per year — or, equivalently, $100 for a bond that pays $2 per year.