The Basics of Bonds

06-Aug-2007

The simplest way to think of a bond is a loan.  When you invest in a bond you are making a loan to (typically) the government, a local authority or a company.   Then, whoever you loaned the money to (the bond) will pay you the interest on the loan.  Usually bonds have a term life of less than 10 years (meaning the bond will be repaid to you within 10 years).  The amount of money that will be returned to you is referred to as the "nominal value."

Bonds may be referred to as loan stock, fixed interest, gilts (when a loan is made to the government), corporate bonds (loans made to companies) and debt securities.  Most people invest in bonds to receive relatively stable and conservative regular income.  However, bonds are not best for people that are seeking more aggressive capital growth.

Bonds are traded on the bond market and their prices may vary.  For example, say you purchase a fixed interest rate bond for £100 and the interest rate is at 8.5%.  If the market interest rates fall below 8.5% this will become a very strong investment and therefore the bond may be valued at £120 or £125.  Or if interest rates rise above 8.5% than the value of the bond could decrease.    If you invest in a corporate bond and the credit rating of the company you invested in falls or rises (meaning the risk associated with that bond or "loan" rises or decreases) then you could expect the market price of the bond to follow along with this change in risk. 

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.