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A bond is simply a debt instrument. It is an instrument that bonds the terms between the lender and the borrower.

Bonds can be issued by governments, corporations and local authorities (states or county councils for example).

There are many forms of bonds but the basics are identical in all cases: the amount of debt , the interest paid and the term, or life-span.

The amount of debt to which the bond refers is called face value or nominal amount and the interest rate is known as the coupon. The life of the bond is categorised as short (0-5 years), medium (5-10 years) or long (over 10 years). Of course some bonds are undated or irredeemable.

At the end of the bond's life (maturity) the capital or face value is repaid to the lender and is known as redemption.

The bonds we are interested in are tradeable in a secondary market just like stocks and shares.

Being tradeable means the bond has a market price. The price is expressed as a percentage of the face value or the price of £100 (or $100) nominal stock. If the price is 100% of the face value then it is said to be 'at par'.

The varying price obviously has an effect on the return of the bond. A bond with an interest rate or coupon of 10% will give different returns at different market prices. A nominal £100 of stock will always pay £10 of annual interest. But if the £100 of stock has been purchased at £50 (£50%) then the return to that purchaser will be 20% (10%/50/100). This return is called the 'yield' or to be precise, the 'flat yield' or 'running yield'. The yield is inversely proportional to the price.

As the capital or face value will be paid at redemption there could be, depending on the price paid, a capital gain or loss. This gain or loss can be added to the flat yield to give the 'redemption yield'.

When buying bonds consideration should be given to the issuer's credit rating. Government bonds are traditionally rated the least risky (depending on the country, of course). Corporate bonds range from Prime and Investment Grade down to 'Junk' bonds.

There are three main credit rating agencies: Moody's, Standard & Poors and Fitch. S&P and Fitch use the well-known ratings of AAA (tripleA) etc., Moody's is slightly different.

The value of bonds is based on several factors including supply and demand but the basic influences are those explained above. That is coupon, term and credit rating (risk).

A further factor to consider is of course prevailing interest rates or the consensus of where interest rates are going:

We know that Y(ield)=C(oupon)/P(rice)

Investors will demand a yield to correlate with current interest rates. Thus if interest rates are expected to rise investors will require a higher yield from bonds. The only way that this can happen is for the price to decrease. Falling interest rates will result in bond prices rising.

We have mentioned credit ratings (risk). What are the risks associated with bonds? There are two risks: Risk of the interest payments being suspended or completely stopping and risk of the capital not being repaid (or not in full).

Of course this article refers to the basic fixed interest bond. There are many variations of the basic bond mainly concerned with the assets upon which the debt is guaranteed. There are also 'zero coupon' bonds and 'callable' bonds

Then there are bonds which incorporate possible participation in equity. These corporate bonds are termed convertible bonds. They are straight bonds but with the added option to convert into shares at, usually, set periods and set prices.

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