What is a bond?

In this video, we explain what bonds are, why they are issued and highlight the critical components that make-up one of the world’s most popular investments.

Key takeaways

• Bonds are a form of ‘IOU’ and represent a loan made by an investor to a borrower. Governments, local authorities, and corporations typically issue bonds as a way of borrowing money from investors.
• Bonds are commonly referred to as fixed income investments because in return for making the loan, the investor gets a fixed rate of interest called a ‘coupon’ throughout the pre-determined term of the bond.
• The price of a bond depends on several factors: the issuers financial strength, the maturity date of the bond, and the duration of the bond (its sensitivity to the change in interest rates)

Glossary

A regular interest payment that is paid on a bond. It is described as a percentage of the face value of an investment. For example, if a bond has a face value of £100 and a 5% annual coupon, the bond will pay £5 a year in interest

How far a fixed income security or portfolio is sensitive to a change in interest rates, measured in terms of the weighted average of all the security/portfolio’s remaining cash flows (both coupons and principal). It is expressed as a number of years. The larger the figure, the more sensitive it is to a movement in interest rates. ‘Going short duration’ refers to reducing the average duration of a portfolio. Alternatively, ‘going long duration’ refers to extending a portfolio’s average duration.

A bond’s term to maturity is the length of time during which the owner will receive interest payments on the investment. When the bond reaches maturity, the principal is repaid.