Fixed Interest Investing – Understanding Bonds
The term bond has in the past been the generic term for fixed interest stocks with security (the borrower is ‘bound’ to repay capital). Gilts are consequently bonds. However, in recent times the term ‘bond’ has also been used in the name of some equity based investments, for example investment bonds issued by insurance companies.
Local and foreign government bonds
It is possible to invest in these and they work like gilts. The only difference is that the risk of non payment is greater, so the provide is higher.
Guaranteed income and growth bonds
These guarantee a comparatively high return over a period, such as five years, with a complete return of capital. They are more attractive during a period of falling interest rates, as the level of interest reflects the going rate at the time of buy.
Income payments are made free of basic tax. They are not appropriate for non taxpayers as tax deducted cannot be recovered.
With income bonds the interest is paid out regularly while with growth bonds it is retained till the end of the investment period. Otherwise, they are identical.
High income bonds
Here a high fixed rate of interest is paid for a period, usually around five years.
The problem with them is that the capital value can be deteriorated. Usually there is a condition that, if a chosen stock market index falls over the investment period by stated amounts, then the capital invested will be reduced by an appropriate percentage.
The lesson here is to read the small print.
These are company fixed interest investments. They function like gilts as the interest rate is fixed and so the market price varies. Interest is taxable but capital gains are tax free.
Debentures and loan stock
Debentures are company fixed interest stocks which are secured on the company’s assets. The term loan stock is used to describe unsecured company fixed interest stocks. Both have redemption dates when the loan will be paid back at a stated price.
Like gilts, the rate of interest is fixed and the market price will vary. Interest on loans is payable whether or not there are any profits and takes preference over dividends. Interest rates are usually quoted gross.
Also like gilts, capital gains are tax free.
These are shares in a company instead of loans to it and usually do not have a redemption date. A fixed dividend is payable out of profits, usually before any dividend on ordinary shares (hence the preference). The market price will vary in accordance with the current rate of interest. Dividend rates are usually quoted net of tax.
Other corporate bonds
Zero coupon bonds are sometimes obtainable. Interest is not paid out but is ‘rolled up’ till redemption or sale and is
then unprotected to capital gains instead of income tax.
‘Bulldog’ bonds are those issued by foreign companies on the sterling market. They give higher yields because of the greater risk.
Eurosterling bonds are issued by companies in the EU (other than UK companies). They are usually bearer bonds, which method they are like money notes so you need to keep them safe!
Corporate bond funds
Unit trusts and investment trusts are mostly equity investments. However, there are also corporate bond funds which invest in a number of individual company bonds, consequently spreading the risk.
High provide corporate bond funds invest in more risky corporate bonds, which have a higher provide but more risk of capital loss.