Bonds Explained
Lending money to governments and companies — and getting paid for it
What Is a Bond?
A bond is essentially an IOU. When you buy a bond, you’re lending money to a government or a company. In return, they promise to pay you interest at regular intervals and return your money on a specific date.
Real-World Example
Imagine your friend asks to borrow £1,000. They promise to pay you £30 every year for 10 years and then give you the £1,000 back. That’s basically a bond — the £30/year is the “coupon” and 10 years is the “maturity.”
Key Bond Terminology
| Term | Meaning |
|---|---|
| Face value | The amount you’ll get back at maturity (usually £100) |
| Coupon rate | The annual interest rate paid on the face value |
| Maturity date | When the bond expires and you get your money back |
| Yield | The actual return based on the price you paid (not always the same as coupon) |
| Credit rating | How likely the borrower is to pay you back (AAA = safest) |
UK Government Bonds (Gilts)
When the UK government needs to borrow money, it issues “gilts” (named after the gilt-edged certificates they were originally printed on). Gilts are considered extremely safe because the UK government has never defaulted on its debt.
Key Concept
Gilts are the bedrock of “safe” investing in the UK. They’re used as a benchmark — other investments are measured by how much more they return compared to gilts (the “risk premium”).
Corporate Bonds
Companies also issue bonds. They typically pay higher interest than gilts because there’s more risk the company could go bust. A bond from a solid company like Tesco pays more than a gilt but less than a bond from a startup. That extra return is compensation for extra risk.
The Interest Rate Seesaw
Here’s the part that confuses everyone: when interest rates go up, bond prices go down, and vice versa.
Real-World Example
You hold a bond paying 3%. The Bank of England raises rates and new bonds now pay 5%. Nobody wants your 3% bond at full price — so its market price drops until the effective yield matches what’s available elsewhere. The opposite happens when rates fall.
Bond Risk Ratings
| Rating | Category | Risk |
|---|---|---|
| AAA | Investment grade | Lowest risk |
| AA / A | Investment grade | Low risk |
| BBB | Investment grade | Moderate risk |
| BB / B | High yield (“junk”) | Higher risk |
| CCC or below | Speculative | High risk of default |
Warning
“High yield” sounds attractive, but it’s a polite way of saying “risky.” These bonds pay more because there’s a real chance you might not get your money back.
Where Do Bonds Fit in Your Portfolio?
Bonds are the “boring but reliable” part of a portfolio. They smooth out the ups and downs of shares. A common rule of thumb is to hold your age as a percentage in bonds (so a 30-year-old might hold 30% bonds, 70% shares), though many modern advisers suggest younger investors can hold less.