When a government needs to fund roads, hospitals, or wars, and when a company wants to expand without issuing more shares, they borrow money. But instead of going to a single bank, they slice that loan into thousands of small pieces and sell them to investors. Each piece is a bond.
The anatomy of a bond
Every bond has three key features:
- Face value (par value): The amount repaid at the end — typically £1,000 or $1,000 per bond.
- Coupon rate: The annual interest rate the issuer pays you, expressed as a percentage of face value.
- Maturity date: When the issuer returns your face value. Bonds can mature in 1 year or 30 years.
Why bond prices move opposite to interest rates
This is the most important concept in fixed income — and the one most beginners miss. Imagine you hold a bond paying 3% when new bonds start paying 5%. Who would want yours? Nobody — unless you discount the price enough to make the effective yield competitive. So your bond's price falls.
The reverse is also true: when new bonds pay only 1%, your 3% bond becomes very attractive, and its price rises.
Types of bonds
| Type | Issued by | Risk level |
|---|---|---|
| Government (Gilts/Treasuries) | UK/US governments | Very low |
| Investment-grade corporate | Large, stable companies | Low–medium |
| High-yield (junk bonds) | Riskier companies | High |
| Emerging market | Developing-country governments | High |
What this means for you
Bonds serve two roles in a personal portfolio. First, they provide income — predictable interest payments that stocks don't guarantee. Second, they provide ballast — when stock markets crash, investors often flee to government bonds, which pushes bond prices up, offsetting some of your losses. This is why most financial advisers suggest holding a mix of both.
The rule of thumb used to be: hold your age as a percentage in bonds (so 30% bonds at age 30). That's outdated, but the principle — that bonds reduce volatility as you age — still holds.
Stocks are a claim on future profits. Bonds are a claim on future cash flows. Knowing the difference is the foundation of portfolio management.