Bonds
A bond is a loan to a company, government or a local authority, and in return you get a regular income from the interest until the loan is repaid.
There are many other names for this type of investment, for example:
- loan stock
- fixed interest
- debt securities
- gilts (loans to the government), and
- corporate bonds (loans to companies).
The main benefit of these investments is that you normally get a regular, stable income. They are not generally designed to provide capital growth.
Bonds have a nominal value. This is the sum that will be returned to investors when the bond matures at the end of its term. Most bonds have a nominal value of £100.
However, because bonds are traded on the bond market, the price you pay for a bond may be more or less than £100. There are several reasons why the price might vary from the nominal value, for example:
- If a bond is issued with a fixed interest rate of, say, 8% and general interest rates then fall well below 8%, then 8% will look like a good yield and the market price of the bond will tend to rise – perhaps from £100 to £110 or £120.
- The reverse is also true. If interest rates rise, the fixed rate of a particular bond might become less attractive and its price could fall below £100.
- Ratings agencies might take the view that a particular company's bond no longer qualifies for a high rating – perhaps the company is not doing as well as it was when the bond was issued. If this happens then the market price of the bond might fall. On the other hand, the company's rating may be improved leading to a price rise.
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The inflation rate might start to creep up and the interest rate on some bonds might start to look less attractive compared with other investments.
Risk
Bonds are generally less risky than having a share in a company. One of the main risks is that the company you have lent money to can't pay the interest due or cannot pay the money back at the end of the term (for example if it has gone bust).
It is generally considered that these risks do not apply to gilts – a government is expected always to pay in full – though there have been instances of certain countries having been unable to repay. Bonds issued by governments will usually pay a lower rate of interest as a result of the perception that they are less risky.
Companies have different credit ratings and a company with a high credit rating is regarded as a safer bet than a company with a low credit rating. Companies with a low credit rating will have to offer a higher rate of interest on their bonds than companies with a higher credit rating, simply to attract investors and to compensate for the higher risk.
Bonds can be bought and sold in the market (like shares) and their price can vary from day to day. A rise or fall in the market price of a bond does not affect what you would get back if you hold the bond until it matures. You will only get back the nominal value of the bond in addition, of course, to any coupon payment to which you've been entitled during your ownership of the bond, irrespective of what you paid for it. If you paid less than the nominal value then you will have made a capital gain when the bond matures and a capital loss if you paid more than the nominal value.
This only applies if you buy a single corporate bond. It doesn't apply to bond funds (pooled investments). Because bond funds invest in many different bonds there is no single maturity date for your investment.
Buying and selling
If you want to buy bonds directly, you can do this through a stockbroking firm; you will pay charges for this similar to buying shares. Alternatively you can buy bonds through a pooled investment.
For gilts, the Debt Management Office has a free booklet called A Private Investor’s Guide to Gilts which gives details on how to buy and sell gilts – see Related links.