Income and Growth Survey: The Name Is Bond

STOCKMARKET VOLATILITY, such as we have seen in recent months, makes investors wary. Rather than punt their cash directly into equities, they are seeking alternatives that will provide higher returns than from a building society account, but without too much risk.

Bonds can be part of a low-risk investment strategy. In essence, they are "loans" of capital by the investor to a private company, the Government, or some other official body. Bond owners will receive regular interest on their savings, plus the repayment of the original investment.

Unlike a typical building society account, the rate of interest of a bond is fixed at the outset, guaranteeing a certain level of income.

Most bonds will have a fixed life, particularly Government bonds, or "gilts". At the end of that life - which could be just a few years or up to 30 years away - the original capital will be repaid by the company or official body which had borrowed it. A few gilts, known as "irredeemables" are undated.

Gilts with less than five years left to run are called "shorts", those with five to 15 years left are called "mediums", those with more than 15 years are known as "longs". While you cannot cash in a bond for its redeemable value before the repayment date, it can still be sold on the stockmarket. It becomes a "tradeable security".

Interest paid on gilts is known as a "coupon". It is fixed for the life of a gilt. The coupon, usually paid twice a year, depends on whatever rates of interest are in place at any moment, plus the borrower's financial strength. For example, gilt rates are lower than those paid by private companies on their bonds. This is because most people assume the Government is less likely to default on the loan.

While a gilt can have face value, this may not necessarily be the price that you pay for it. Bond prices can go up or down, depending on a range of factors. One of those is the level of interest rates. When interest rates rise, the price of a bond falls and vice versa.

This is because a bond paying a coupon/yield of, say, 5 per cent will become less attractive if interest rates rise to 6 per cent. Alternatively, should interest rates fall to 4 per cent, a bond paying more than that becomes more sought-after. The lesson to be learnt here is that the current yield, based on the price paid for a bond, is more important as an indicator of income than the coupon.

Equally important, assuming that you keep a bond until maturity, is its redemption yield. This is the term used for the earnings received from the interest paid to you, plus losses or gains on the capital invested when the bond is redeemed.

There are many different types of bonds:

n Gilts are bonds issued by the Government. They are considered among the safest form of investment.

n Index-linked gilts, which are also issued by the Government, differ from conventional gilts because payments they make are linked to inflation.

n Corporate bonds are issued by private companies which offer a certain rate of interest to investors. A company's bonds are assessed by credit rating agencies.

n High yield corporate bonds, otherwise known as "junk bonds", are an extension of corporate bonds. They pay a higher yield because their credit rating is lower.

n Preference shares have no redemption date. They pay a fixed dividend. They are perceived as being higher-risk than ordinary corporate bonds.

n Convertibles provide the option of converting into the ordinary shares of a company. They too pay a fixed rate of interest per share - up to the moment of conversion.

n Floating rate notes (FRNs) are securities typically issued by banks. They offer a rate of interest fixed for three months. The rate is higher than from cash deposits.

n Treasury Bills are short-term securities issued by the Government. They usually have a maturity date of just three months.

n Certificates of deposit are issued by both banks and businesses. They are deposits that can be bought and sold in the stockmarket.

n Zero-coupon bonds do not pay interest, but are issued at a large discount to their face value, so a return comes in the form of capital gains.

n Permanent interest bearing shares (PIBS) are issued by building societies, and are effectively shares in that society. They have no redemption date.

Nic Cicutti

Start your day with The Independent, sign up for daily news emails
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Executive - OTE £40,000

£15000 - £18000 per annum: Recruitment Genius: This is a great opportunity for...

Austen Lloyd: Law Costs HOD - Southampton

£50000 - £60000 per annum + Excellent Salary: Austen Lloyd: An outstanding new...

SThree: Recruitment Resourcer

£20000 - £21000 per annum + uncapped commission: SThree: As a graduate you are...

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Day In a Page

Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

Climate change key in Syrian conflict

And it will trigger more war in future
How I outwitted the Gestapo

How I outwitted the Gestapo

My life as a Jew in wartime Berlin
The nation's favourite animal revealed

The nation's favourite animal revealed

Women like cuddly creatures whilst men like creepy-crawlies
Is this the way to get young people to vote?

Getting young people to vote

From #VOTESELFISH to Bite the Ballot
Poldark star Heida Reed: 'I don't think a single bodice gets ripped'

Poldark star Heida Reed

'I don't think a single bodice gets ripped'
The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn