What is a bond?

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WiseAlpha’s educational series: Teaching you everything you need to know about the bond market and more.

Bonds are often less well understood by the average private investor. Why is that? The vast majority of corporate bonds are not as widely available to private investors and as a consequence there is less press/media coverage of bonds compared to other asset classes like equities which are broadly available through numerous brokers. As it turns out, bonds are much simpler than investing in shares and can be a less risky and, a more predictable way to make a return.

Bonds are a form of borrowing and investing in a bond is a form of lending. The bond issuer is legally obliged to pay a coupon (interest payment) regularly and repay the entire amount that was borrowed at the outset by a certain date (called maturity date). This creates a strong level of predictability for investors both in terms of the return they will make and from the expectation of receiving their capital back at maturity. If we compare this to investing in shares, shares provide no contractual certainty of dividends and no expectation of capital repayment but instead the hope of a capital gain from a rise in the share price.

Bonds are also traded in a secondary market similar to shares. This allows investors to buy bonds with a shorter time to maturity and to also get liquidity if they need to sell their bond early. Bond prices can also move up or down but are generally less volatile than equities, so it is possible to realise higher or lower returns if a bond is sold before maturity. As with shares, the value of an investment in a bond can go up or down depending on the financial performance of a company so for example if Tesco’s results are good the bond price may increase (and vice versa) although the price movements are not likely to be as large as with the shares.

Please remember that bonds are investments not savings or deposit protected products and your capital and interest is at risk.

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