Investment Bonds

 Government bonds or gilts are investments which can be freely traded and allow governments to tap the international money markets to fund the shortfall between what they spend and what they raise in taxes.

These government bonds provide investors with a fixed rate of return.

 Gilts are the popular name for UK government bonds. Bunds is a similar term for government securities issued by the German government and US treasuries is the term used for similar instruments issued by the Federal Reserve Board in the United States.

 Every traditional gilt edged stock pays out interest twice a year and the amount they pay can be calculated by multiplying the face value of the holding by the coupon or rate of interest shown in the title of the gilt. Thus £100 of Treasury 8% 1999 will always pay two interest payments during the year of £4.

The rate of return is "fixed", not "variable" as it is for ordinary shares, bank and building society deposits.

There is little or no risk in holding gilt edged stocks as long as they are bought at a price which is below their repayment value of £100. The twice yearly interest payments are guaranteed by the UK government and the repayment value is similarly guaranteed. Thus, if you buy £100 Treasury 8% 1999 at a price of £97, you are certain to receive £8 every year, and you are also certain to receive repayment on your investment at a price £3 greater than today's price in 1999.

Gilt edged stocks are used mainly by insurance companies, pension funds, charities and trusts, all of whom generally want safe, high yielding investments. Because there are a large variety of different stocks with different repayment dates, these types of institutions tend to match their liabilities with gilts. Individuals, too, can use them for this purpose, for example to fund a tax liability in a year or two's time or perhaps to plan for retirement on a known date.

What factors determine the price of a bond?

 The return from bonds generally stands a little higher than the return from money in the bank or on deposit at the building society. General movements in interest rates, therefore, affect the prices of a bond because the price per £100 will be forced to move so that the actual return from the gilt always remains slightly ahead. 

National Governments are not alone in finding that they have a shortfall every year between what they spend and what they can raise and the Local Authorities, in trying to meet the rising social demands of residents - for education, social services, police, etc., - are big users of the bond market. Many of the 100 biggest companies also raise considerable money from bonds, particularly convertible bonds where the cost of raising money is cheaper than borrowing from the bank.

The ability to include corporate bonds in Individual Accounts (ISAs) gives investors more flexibility in the sort of securities which can be included. Typically, the yield on shares is relatively low - 3% or 4%. This has tended to put some investors off investing in Corporate Bonds - particularly retired investors who need income.

But now, ISA managers can include corporate bonds and this has had the effect of improving the yield which is available to 7% or 8% or more.

In general, ISAs are a good idea because of their complete exemption from Capital Gains Tax and from Income Tax, but the amount that can be invested is restricted to £7,000 in each financial year per individual. 

 Corporate bonds are less risky than shares for two reasons. Firstly, in falling markets, they tend not to fall as far as ordinary shares because of their yield attractions- e.g. they pay a higher rate of investment return than shares.

Secondly, corporate bonds tend to be higher in the pecking order than ordinary shares if a company goes into liquidation and the assets have to be sold in order to refund as much as possible to investors.

These are the bonds of companies which have gone into liquidation.

Market professionals try to make an assessment of how much the company's assets will raise and from this, how much might be available for the secured corporate bond holders. This gives an approximate indication of the worth of the bond and, after applying a suitable discount, there is the basis of a price at which risk averse investors can dispose of their stock. The buyers of such stocks tend to be those prepared to take a high risk, either that the company will eventually recover or that the liquidator will produce enough to pay off the bond holders at a price higher than they have paid for the stock. This is generally not a market for private investors.