Next up for our 4 in 1 is bond. No not Mr Bond, but a financial bond. What is this less well-known Bond about anyway? Below we break down what a bond is into one sentence, one paragraph, one image and one short article.
A bond is an IOU. The borrower is a government or company and the lender is the investor.
Governments need to pay for things such as schools and hospitals. Companies need to pay for things such as employee salaries and advertisements. All these things come with a price tag. One way to pay for all this is to borrow money from investors. The investors can be a person (”you”), a group of people or another company. When a government or a company borrows money, it is a bond (aka an IOU). It works by you lending money to a government or company, who will then promise to pay your money back at a date in the future. Not only that, but they’ll also pay you some extra money for lending them the money. This extra money is paid in instalments to you and they're called interest payments.
What is a bond?
A bond is an IOU. The borrower is a government or company and the lender is the investor. The investors can be a person (”you”), a group of persons or another company. Governments and companies need to raise money to pay for the services and products they provide. This costs money. Cha-Ching! To try and meet these costs, governments and companies borrow money from investors. This is the bond.
Each bond has a value. For example, a company will give you a bond worth £1,000 in exchange for £1,000 cash. The company will pay you back £1,000 at a future date, for example in 5 years. They'll also pay you some extra money, which is known as an interest payment. The extra money is paid until the money you lent is paid back. For example, if you bought a £1,000 bond and the company agreed to pay you 5%, then you'll be paid £50 per year until you were paid back the £1,000.
The set time by which the money needs to be paid back usually ranges between 2 and 10 years. So if you buy a 10-year bond for £1,000, you’ll get back your money in 10 years. Once you've been given your money back, you'll no longer get extra money from the company each year.
Why are they less risky than shares?
Remember company shares which we talked about in our last 4 in 1? The main difference between a company's share and a bond is that the company is making a promise to pay you back. When you buy a share, there is no promise to pay your money back. For this reason, bonds are less risky than shares. You’ve got less chance of losing your money when you buy a bond. On the flip side, a bond won’t make you as much money as company shares. This is because you'll only get your money back, plus the extra money the company has agreed to pay you.