What is a bond?

Demystifying investment terms

A bond is essentially a loan made by an investor to a company or government. In return, that company or government pays interests, normally at a fixed rate, over a fixed term.

Bonds are one of the oldest forms of investment. With the first ever recorded bond dating back to 2400 BC. It was issued in Mesopotamia where the currency of choice was bags of grain. Since then the bond market has grown highly complex and sophisticated, and a fund manager needs considerable skill to sort the wheat from the chaff.

Today there are many types of bond but we have listed three of the most common below:

Government bonds are widely regarded as the safest type of bond to invest in, since they’re backed by the governments that issue them. However, they generally offer lower interest rates than bonds issued by companies. Governments usually issue bonds in their own currency and carry varying levels of risk depending on the economic situation of the issuing government. Since foreign government bonds are often issued in their own currency, if your domestic currency differs to theirs, your investment will fluctuate as exchange rates move.

Corporate Bonds are issued by companies. Corporate bonds generally offer higher yields than government bonds because there’s a perceived higher risk of a company defaulting on the interest payments. The lower the company’s credit quality, the higher the interest you're paid. This is because you are potentially taking on more risk.

Convertible bonds are issued by companies and can be exchanged for stocks, usually of the same company.

Things to discuss with your adviser

A popular way to invest in bonds is via a bond fund, which offers a share in many different types of bond. This can help you to spread the risk of any individual company or nation defaulting on a bond, and an expert fund manager may be able to assess the risk of default more accurately. Within each broad bond market sector you’ll find different issuers, credit ratings, coupon rates, maturities, yields and other features. Each one offers its own balance of risk and reward. There are other bond types such as inflation-linked gilts, zero rated and callable bonds, but these are more complex. To understand more about these, please contact your adviser.

Like all investments, bonds can fall in value and you can lose your whole investment if the issuer cannot pay you back.

To understand more about some technical words mentioned in the article, please refer to our glossary.