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 celebration of British elections
  • Get to the point
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

SThree: Trainee Recruitment Consultant - Swiss Banking and Finance

£20000 - £25000 per annum + Uncapped commission: SThree: Can you speak German,...

Ashdown Group: Marketing Executive - 6 month FTC - Central London

£25000 - £30000 per annum + benefits: Ashdown Group: An exciting opportunity f...

Ashdown Group: Junior Project Manager (website, web application) - Agile

£215 per day: Ashdown Group: Junior Project Manager (website, web application ...

Guru Careers: Software Engineer / Software Developer

£40-50K: Guru Careers: We are seeking an experienced Software Engineer / Softw...

Day In a Page

General Election 2015: Ed Miliband's unlikely journey from hapless geek to heart-throb

Miliband's unlikely journey from hapless geek to heart-throb

He was meant to be Labour's biggest handicap - but has become almost an asset
Amr Darrag: Ex-Muslim Brotherhood minister in exile still believes Egypt's military regime can be replaced with 'moderate' Islamic rule

'This is the battle of young Egypt for the future of our country'

Ex-Muslim Brotherhood minister Amr Darrag still believes the opposition can rid Egypt of its military regime and replace it with 'moderate' Islamic rule, he tells Robert Fisk
Why patients must rely less on doctors: Improving our own health is the 'blockbuster drug of the century'

Why patients must rely less on doctors

Improving our own health is the 'blockbuster drug of the century'
Sarah Lucas is the perfect artist to represent Britain at the Venice Biennale

Flesh in Venice

Sarah Lucas has filled the British pavilion at the Venice Biennale with slinky cats and casts of her female friends' private parts. It makes you proud to be a woman, says Karen Wright
11 best anti-ageing day creams

11 best anti-ageing day creams

Slow down the ageing process with one of these high-performance, hardworking anti-agers
Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever