If You're New to Bonds, Learn Face Rate vs. Market Rate First -- Korea's Retail Treasury Bonds Only Give You the Tax Break If You Hold to Maturity

A bond is really just a promise: 'by when, and how much'

A bond is a certificate issued by a government or a company when it borrows money. The issuer promises to repay the principal at a set maturity date and to pay interest at a set coupon rate in the meantime. Unlike a stock, the promised interest and principal stay fixed whether the company does well or poorly -- though if the issuer defaults, you may not get paid at all, which is why the risk level differs sharply between government bonds (issued by the state) and corporate bonds (issued by companies). It's also a basic property of bonds that if you simply hold to maturity, you receive the agreed principal and interest regardless of how the price moved in between.

The coupon rate and the market rate are two different rates

The coupon rate is fixed when the bond is issued and doesn't change until maturity. The market rate, by contrast, keeps changing afterward depending on prevailing interest-rate conditions. Because an already-issued bond's coupon rate is locked in while the market rate moves up and down, the price at which that bond trades in the meantime shifts as a result.

Why does a bond's price fall when the market rate rises?

When the market rate rises, newly issued bonds carry a higher coupon rate. That makes an older bond issued at a lower coupon rate relatively less attractive, so anyone trying to sell it has to lower the price before a buyer will bite. Conversely, when the market rate falls, an older bond with a higher coupon rate becomes relatively more attractive and its price rises. This is what people mean when they say bond prices and market rates move in opposite directions.

Retail Treasury Bonds -- savings-style government bonds only individuals can buy

Introduced in 2023, Retail Treasury Bonds are savings-style government bonds that only individuals may subscribe to. For bonds with a maturity of five years or more (10-year and 20-year terms are standard), interest income is taxed separately at 14% (15.4% including local tax) on up to 200 million won in principal purchased, provided you hold to maturity. Ordinary interest income can be combined with other income and taxed at a higher rate, so the fact that the rate stays fixed within this cap is the core benefit.

The coupon rate follows the previous month's Treasury bond auction rate

The coupon rate on Retail Treasury Bonds follows the winning auction rate on regular Treasury bonds of the same maturity issued the previous month, and on top of that, a spread rate is newly set and announced each month based on market conditions. The coupon rate and spread rate fixed at the time of purchase are locked in until maturity, so regardless of whether the market rate later rises or falls, the buyer's principal and promised interest do not shrink. Because of this, subscribing in a month when the announced spread rate is higher can lock in a better deal for the same maturity -- so it's worth checking that month's announced terms rather than rushing to buy immediately.

Cash out early, and most of the benefit disappears

Here's the part that's easy to miss. If you redeem a Retail Treasury Bond before maturity, the spread rate, the compounding effect, and the separate-taxation benefit all stop applying. You're paid back based on simple interest at the coupon rate alone, since the product's benefits are designed on the assumption that you hold to maturity. This works on the same principle as the way early termination of a Youth Leap Savings Account forfeits the government's matching contribution and tax exemption -- the longer the product's term, the more important it is to calculate the opportunity cost of cashing out early before you commit.

Government bonds, corporate bonds, and deposits all carry different risk

Because the government is the issuer, Treasury bonds carry practically low default risk but also a lower coupon rate, while corporate bond rates vary widely by the issuing company's credit rating. A corporate bond with a lower credit rating pays a higher coupon rate precisely because the risk of not getting paid back is that much greater -- not because it's a safer bond. If you already understand why interest rates and stock prices move in opposite directions, you can apply the same logic to the relationship between bond prices and rates. And unlike a deposit, where the principal is protected under the deposit insurance limit, a bond sold before maturity can return less than the principal depending on the market rate -- meaning bonds carry more price-swing risk than deposits do. Assuming "a bond is as safe as a deposit" is a good way to be caught off guard when you actually try to sell one early.

Putting it in order

① When buying a bond, distinguish the coupon rate (fixed) from the market rate, which keeps changing. ② Remember that when the market rate rises, existing bond prices fall, and when it falls, prices rise. ③ Confirm that a Retail Treasury Bond gets separate taxation (15.4%) only up to 200 million won in principal and only if held to maturity. ④ Keep in mind up front that redeeming early wipes out the spread rate, compounding, and tax benefits. ⑤ Remember that the higher a corporate bond's coupon rate, the greater its credit risk tends to be.