A safe form of investment
All investments contain some element of risk, but some are more risky than others. Depending on circumstances, and your risk preferences, you may wish to keep some of your funds in relatively risk-free waters. If this is your objective, bonds may be an ideal investment choice.
A bond is a financial instrument, usually long-term, which is similar to an IOU. When you purchase a bond, the issuer (government, bank or corporate) is promising to pay you its face value (the principal) at maturity and, in the majority of cases, interest on a periodic basis.
Bonds are negotiable certificates which represent how much the issuer owes the holder. The negotiable element refers to the fact that, through a broker, ownership of a bond can be transferred from one party to another.
Bond returns
Coupons are the interest payments made by the issuer to the holder until the bond matures. They are usually expressed as an annual percentage of the face value. Coupons can be paid annually, half-yearly or more frequently.
If, for example, you purchase a bond worth GBP 1,000 with a coupon of 4% per annum paid half-yearly, you will receive an interest payment of 4% per annum (2% every six months) throughout the life of the bond.
The interest rate on a bond may be on a fixed or floating basis. Fixed interest rates are predetermined and fixed for the life of a bond. Interest rates on a floating rate basis are linked to short-term interest rates (reference rates).