fbpx

Bonds 101

Bonds represent a major asset class and here we explain what they are and why they may be of interest when considering the make-up of your investment portfolio.

What are gilts, government bonds and corporate bonds?

Investing in gilts, government bonds and corporate bonds effectively means lending money to different bodies, be it companies or governments, which pay you a regular income in the form of interest for a set period of time, after which your loan must be repaid.

They are designed to pay you a steady income and tend not to offer opportunities for capital growth – at least, not in normal economic times. The most common forms of fixed-interest investment are:

Gilts and index-linked gilts
Other government bonds
Corporate bonds

Gilts

These fixed-interest securities are issued by the British government when it wants to raise money. Gilts are generally considered to be very low-risk investments because it is thought to be highly unlikely that the British government will go bankrupt and therefore be unable to pay the interest due or repay the loan in full. Index-linked gilts pay interest linked to the Retail Prices Index (RPI), so their value moves in line with inflation.

Other government bonds

Government bonds are also issued by governments around the world to raise money. As the Eurozone crisis demonstrated, some governments prove safer bets than others, as anyone owning Greek government bonds before the crisis will have found out.

Corporate bonds

Corporate bonds are issued by companies that are looking to raise capital. They are seen as riskier than gilts, as companies are generally considered to be more likely to default on debt than stable governments. Corporate bonds tend to offer a higher rate of interest to reflect this extra risk.

Returns from gilts and corporate bonds

If you buy £1,000-worth of Treasury stock 3% 2020 gilts, you would receive 3%, or £30, every year until your £1,000 loan is repaid in 2020. The income you receive is called the ‘income yield’, ‘running yield’ or ‘interest yield’ and is paid twice a year (1.5% or £15 every six months, in this instance).

The interest paid on corporate bonds is determined by the length of time you must wait for maturity and/or the riskiness of the company within which you invest. The further away the redemption date, the higher the interest you will receive, as you are having to wait longer to be repaid. Similarly, the greater the risk you take on a company, the higher the interest rate you can expect to receive.

Gilts and corporate bonds on the secondary market

You can buy gilts at issue from the government’s Debt Management Office, but most gilts, government bonds and corporate bonds are traded on a secondary market, and their value can fluctuate based upon interest rates and the solvency of the issuer. Bond prices will rise when general interest rates are low because the rates of interest they pay are fixed and will beat the short-term rates available from banks. Therefore, you may buy a bond or gilt for an amount above or below the nominal value, and this will have an impact on both how much interest you receive as an income and the amount of money you will receive when the bond matures.

It works like this:
If, for example, you paid £95 for a gilt, government bond or corporate bond with a nominal value of £100, you will make a capital gain when it matures, as the loan is repaid at the nominal value. Similarly, if you bought the gilt, government bond or corporate bond for £105, you would lose out on maturity, as you’re only paid back at the nominal value. The amount of interest you’ll receive will also change dependent on the price you paid. If you buy a bond or gilt paying 6% for, say, £95, the effective interest rate you’ll receive is higher than 6% as interest is paid on the nominal value, not the second-hand market price you paid. In this example, the rate you receive is actually 6.32% (i.e. 6%/£95 = 6.32%).

Gilts, government bonds and corporate bonds are given credit ratings by companies, such as Standard and Poor’s, Fitch and Moody’s.

The below table shows Standard and Poor’s ratings:
Fixed interest credit ratings explained

If you are interested in finding out more about bonds and whether investing in bonds is suitable for you, please feel free to get in touch.

jonathan@truwealth.co.uk
0141 212 3983

*Please note when investing, there’s always the risk that your investment could fall in value as well as rise. This means you could get back less than you invested.

Sources:

https://www.which.co.uk/money/investing/how-investing-works/guides/asset-classes-explained/gilts-and-corporate-bonds-explained

https://www.investopedia.com/university/bonds/

Tags: , , ,

© 2019 All Rights Reserved by Tru Wealth Ltd. is an Appointed Representative of Morton Hill Ltd which is authorised and regulated by the Financial Conduct Authority
Tru Wealth Ltd FCA Number 776859 Registered in Scotland No SC440074. Registered address Moncrieff House, 5th Floor 69 West Nile Street, Glasgow, G1 2LT