Investing in Bonds
Invest by lending money to a government or company for an agreed period. Bonds can provide interest payments and repayment of their face value at maturity, although their market value can rise or fall and the issuer may be unable to make the payments promised.
What is a bond?
A bond is a form of borrowing used by governments, companies and other organisations. When you buy a newly issued bond, you are lending money to the issuer rather than buying an ownership stake in it. In return, the issuer agrees to make payments according to the bond’s terms and normally repay its face value when the bond reaches maturity.
Many bonds pay interest, often called a coupon, at specified intervals. Bonds can also be bought and sold after they have been issued, which means their market price can rise or fall before maturity. The return you receive can therefore depend on both the payments made by the issuer and the price at which you buy or sell the bond.
How investing in bonds works
A bond sets out how the borrowing arrangement is intended to work, including its face value, any interest payments and when it is due to mature. You can hold a bond until maturity or, where a market exists, sell it to another investor before then.
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01
The bond is issued
A government, company or other organisation raises money by issuing bonds. Each bond has terms that set out matters such as its face value, maturity date and any interest payments.
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You buy the bond
You may buy a bond when it is first issued or later from another investor. If you buy it after issue, the market price may be higher or lower than its face value.
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03
Interest may be paid
Many bonds make regular interest payments, known as coupon payments. The amount and timing depend on the bond’s terms, and not every type of bond pays interest in the same way.
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04
You hold or sell it
You can potentially sell a tradable bond before it matures. Its market price may have risen or fallen since you bought it, so selling can result in a gain or loss.
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The bond reaches maturity
If you still hold the bond at maturity, the issuer is normally due to repay its face value. This depends on the issuer being able to meet its obligations.
How bonds can make or lose money
The outcome from a bond depends on the price you pay, the interest you receive and whether the issuer makes the payments it has promised. If you sell a bond before it matures, changes in its market price can also affect your return.
Interest and repayment
Many bonds pay interest, known as a coupon, during their life. If you hold a bond until maturity, the issuer is normally due to repay its face value. The price you originally paid for the bond may be higher or lower than that amount.
Changes in the bond's market price
If you sell a bond before maturity, you may receive more or less than you paid for it. Bond prices can change as interest rates, inflation expectations, the issuer’s financial position and demand from investors change.
A simple example
Suppose you buy a bond with a face value of £1,000 for £1,000. If you hold it until maturity and the issuer makes all the promised interest payments and repays the £1,000 face value, those interest payments form your return. If instead you sell the bond before maturity for £950, you receive £50 less from the sale than you originally paid, although any interest you received while holding it also forms part of your overall return.
A bond’s coupon rate alone does not tell you the return you will receive. The price you pay, the interest received, whether you sell before maturity and whether the issuer meets its obligations all affect the outcome.
What are the risks of investing in bonds?
Bonds are sometimes viewed as less risky than shares, but they are not risk-free. The level and type of risk can vary considerably between bonds depending on the issuer, the terms of the bond and how long it has until maturity.
Credit and default risk
The issuer may experience financial difficulties and be unable to make interest payments or repay the amount owed. Bonds issued by different governments and companies can have very different levels of credit risk.
Interest-rate risk
Changes in market interest rates can affect bond prices. When interest rates rise, existing fixed-rate bonds generally become less attractive and their market prices tend to fall. Bonds with longer until maturity can be particularly sensitive to changes in interest rates.
Inflation risk
Inflation can reduce the purchasing power of the interest and capital you receive from a bond. This can be particularly important for fixed-rate bonds because their promised cash payments do not normally increase when prices rise.
Liquidity risk
Some bonds can be harder to sell than others. If there are few buyers when you want to sell, you may have to accept a lower price or may not be able to sell as quickly as you expected.
What types of bonds can you invest in?
Bonds can differ considerably in who issues them, how interest is paid and how long the money is borrowed for. These characteristics can affect both the potential return and the risks involved.
Government bonds
Governments issue bonds to borrow money, with UK government bonds commonly known as gilts. Government bonds from different countries can carry different levels of credit, interest-rate and currency risk.
Corporate bonds
Companies can issue bonds to raise money from investors. The risk and return can vary considerably depending on the financial strength of the company and the terms of the particular bond.
Fixed-rate and inflation-linked bonds
Many bonds pay interest at a fixed rate, while some are designed so that payments or the amount repaid are linked to inflation. This can cause different types of bonds to respond differently when inflation and interest-rate expectations change.
Different maturity periods
Bonds can mature over periods ranging from relatively short terms to several decades. Longer-dated bonds are generally more sensitive to changes in market interest rates than otherwise similar shorter-dated bonds.
The word ‘bond’ therefore covers investments with very different characteristics. The issuer, interest terms, maturity, currency and other conditions all help determine how a particular bond may behave.
Government bonds vs corporate bonds
Bonds can be issued by governments as well as companies. Both involve lending money to an issuer, but the reasons for borrowing, level of credit risk and interest offered can differ.
Government bonds
Issued by governments
Governments issue bonds to borrow money and finance public spending. UK government bonds are commonly known as gilts.
Risk and return
The risk depends on the government issuing the bond and its ability to meet its obligations. Bonds considered to have lower credit risk will generally offer lower yields than otherwise similar bonds carrying greater credit risk.
Corporate bonds
Issued by companies
Companies can issue bonds to raise money for purposes such as investment, expansion or refinancing existing borrowing. Buying a corporate bond makes you a lender to the company rather than an owner of it.
Risk and return
The financial strength of the company affects the risk that it may be unable to make the promised payments. Investors will generally expect higher yields from bonds carrying greater credit risk.
The label ‘government’ or ‘corporate’ does not by itself tell you how risky a bond is. The financial strength of the individual issuer, the bond’s terms, its maturity and the price you pay all need to be considered.
Want to explore other ways to invest?
Bonds involve lending money to governments or companies. Shares, funds and ETFs provide different ways to invest, with important differences in ownership, diversification, how returns arise and the risks involved.
Shares
Invest directly in individual companies, with returns depending on changes in their share prices and any dividends paid.
Explore shares →Funds
Pool your money with other investors in a portfolio of investments managed or tracked according to the fund’s approach.
Explore funds →ETFs
Invest in a portfolio of assets through a fund that is bought and sold on a stock exchange.
Explore ETFs →How are investments in bonds protected?
Investment protection works differently from protection for cash savings. The FSCS does not compensate you simply because a bond falls in value or an issuer fails to make its promised payments, but protection may apply in certain circumstances involving an authorised financial firm.
If your bond falls in value
Normal investment losses are not covered by the FSCS. If the market value of a bond falls because of changes in interest rates, the issuer’s financial position or wider market conditions, you could receive back less than you invested.
If an investment firm fails
FSCS protection may apply to an eligible investment claim if an authorised firm fails and cannot meet a valid claim against it, including in some circumstances where there is a shortfall in money or assets it was holding for you. Investment protection is currently limited to £85,000 per eligible person, per firm, subject to the circumstances and eligibility rules.
Check the firm and the investment
Before investing, check whether the firm you are dealing with is authorised and whether the activity involved is eligible for FSCS protection. Protection can depend on the firm, the service provided and the circumstances of a claim.
FSCS investment protection should not be confused with protection against a bond issuer defaulting or the bond losing value. It does not guarantee the payments promised by a bond or protect you from normal investment losses.