Understanding Bonds

Companies and governments sell bonds to raise money without issuing shares. They are effectively fixed-term loans bought by investors who receive interest until the end of that term.

How It Works

Bonds are securities for long-term debt, although they are not always held until the end of their term. The price of a bond rises and falls depending on current interest rates, and on how likely investors feel the bond issuer is to repay the initial sum invested. There are different kinds of bonds such as savings bonds company bonds, and government bonds (also known as US Treasury securities), and some can be traded between investors. In savings bonds, investors deposit a lump sum with a retail savings institution (such as a bank), receive regular interest, and are repaid the original sum in full. In other types of bond, repayment of the original sum is not guaranteed, since the issuer could go bust. Because the risk of government default is so small, gilts are seen as the least risky bond type.

Investing In Bonds

When choosing a bond, investors must balance the total sum received in interest against the likelihood of the capital sum (initial cash investment) actually being repaid at the end of the term. They must also decide whether a bond offers good value by analyzing its current yield. This compares the interest paid by the bond with its current value on the secondhand market. Although bondholders have a slightly higher chance of being paid than shareholders if a company collapses, there is no guarantee of payment.