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How do you buy Bonds?
You can buy bonds in:
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the "Primary Market". When the bond is first created and sold to investors, we call this the new issue primary market. It's a bit like an equity IPO. Your broker will contact you when there is a new issue
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the "Secondary Market". This is when you buy (or sell) via your broker after the bonds are first issued. The process is the same with bonds as it is with equities
Bonds - are they risky?
First things first. Bonds are not deposits! Bonds are an investment and like any investment, they go up and down in value. If you sell below the price you paid, you'll lose money. If you hold the bond to maturity and the issuer hasn't defaulted, you'll get the face value of the bond back.
Let's use an example. Company A has listed equity (shares) and listed bonds. Which is more risky?
The answer is the equity is more risky. The shares of Company A are more volatile because you own part of the business. Whilst companies like to pay dividends, they don't have to because they might have to reinvest in new equipment or technology.
Contrast that with bonds. Company A is obliged to pay you interest and it must pay that interest before it spends money on other things. Think of your mortgage. If things get tight you cut back on the unimportant things and prioritise the mortgage payments so you don't default. It's the same for Company A: making its interest payments becomes the most important objective and that comes at the expense of shareholders who may receive no dividend.
And that's why you get a fixed rate and your return will be expected to be lower than if you invest in the equity.
Bonds pay a lower return because you get paid first. And if things did go wrong, bondholders rank ahead of the shareholders in any liquidation.
Less risk = lower return
Bondco sells a three-year bond at "par" (which means £100 face value). It offers 5% interest per year, paid semi-annually. You pay £100 (the face value of the bond in the primary market).
The bond's price in the secondary market is £100 during the first year. In the second year, the bond trades down to a low of 80 because of concerns in the economy. During the third year, the bond trades back up to 100 in anticipation that Bondco will repay the bond at £100.
Let's look at what happens if you hold the bond to maturity:
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you will receive six interest payments of £2.50 on each interest payment date (every six months) regardless of what happens to the price of the bond in the secondary market
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at maturity, you get back £100
Let's look at what happens if you decide to sell the bond before maturity:
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If you sold during the first year, you'd get your £100 back because the price in the secondary market is £100. You would also receive the interest owed to you. Your yield would be 5%
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If you sold at the worst point in the second year, you would lose £20 because the price in the market is £80. You would also receive the interest owed to you but your yield would be less than 5% (because of your £20 loss)
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Think about this though: you have confidence in Bondco and you buy another bond for £80 at the end of year 2. Your return on this bond would comprise of two interest payments, each £2.50, and £100. The yield on this bond would be much more than 5% because of the price (£80) at which you bought the bond
Mission
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Vision
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