What is
A glossary of bond terms
The words you will meet on a platform or in a fund document, in plain English.
Every one of these turns up on an investment platform or inside a fund document, usually without being explained. None of them is complicated once it is written out.
Bond. A loan agreement made between an issuer, such as a government or a company, and a lender, who is the investor.
Coupon. The fixed interest, or income, a bond pays the investor at regular intervals through the bond's life: quarterly, half-yearly or annually. That regular payment is what the phrase fixed income refers to. It differs from shares, where investors may receive dividends but those are paid at the company's discretion and are not a legal obligation.
Covenant. A legal agreement between the bondholder and the issuer setting out what the issuer must do during the bond's lifetime. At its simplest a covenant requires the issuer to pay the coupon and repay the principal, and it is enforceable by law.
Default. Every bond carries the risk that the issuer fails to repay the loan in full at maturity. If that happens it is called a default. Worth knowing: if a business fails, bondholders are paid before shareholders, which may allow them to recover some capital, typically 30 to 50 per cent depending on the issuer's situation.
Duration. When interest rates rise, bond prices usually fall, and the reverse. Duration measures how sensitive a bond is to those changes. The duration of a portfolio also shifts over time, as bonds mature or as rates move.
Face value, par, or principal. The amount the issuer is obliged to repay when the bond matures, assuming no default.
High yield bonds. Also called non-investment grade, speculative or junk bonds. Issued by companies with lower credit quality and a higher risk of default than investment grade firms.
Investment grade corporate bonds. Issued by robust, often well known companies with strong credit ratings, which suggests a lower risk of default.
Issuer. Whoever wants to borrow the money by issuing the bond: a government, a company, or a government agency.
Maturity. The date the bond ends and the issuer repays the principal, which is the original loan amount.
Ratings. Independent agencies such as Moody's and Standard & Poor's assign bonds a credit rating. It tells an investor how probable it is that the issuer will pay the coupon and repay the principal on time. If a rating is downgraded the bond becomes less attractive and its price may fall.
Short dated bonds. Bonds with a short life, maturing in under five years, though the market often means under three. The shorter the time to maturity, the less the price moves when interest rates shift.
Spread, or credit spread. The difference in yield between two bonds, usually reflecting the extra return for taking more risk. If a government bond pays a 4 per cent coupon and a corporate bond pays 6 per cent, the spread is two percentage points. Spreads compare bonds of similar maturity but different credit quality, and are a common indicator of market sentiment.
Yield. What an investor actually receives for lending their money. The coupon is the fixed rate set when the bond is issued; the yield moves with the bond's market price. When the price rises the yield falls, because you paid more for the same coupon. Buy below face value and your effective yield is higher.
Yield to maturity. The total estimated annual return from buying a bond at its current market price and holding it to maturity. Because it takes the whole picture into account, it is a useful way to compare one bond with another.
Yield curve. A graph of the relationship between a bond's yield to maturity and its time to maturity, usually plotting bonds of the same credit rating with different maturity dates. The shape says what the market expects interest rates to do: an upward slope suggests participants think rates are heading up. Because it reflects sentiment about future rates, it is a useful indicator of the wider economic outlook.
The sectors a bond fund is sorted into
The Investment Association groups fixed income funds into sectors, which is how a platform lists them. In order of duration: Short Term Money Market, Standard Money Market, Sterling High Yield, Sterling Strategic Bond, Sterling Corporate Bond, UK Gilts, and UK Index Linked Gilts.
For what sits inside each part of the market rather than what the words mean, see the types of bond sector.
Information, not advice. This guide is general information to help you understand your options. It is not personal advice and not a recommendation to buy, sell or hold any investment. If you are unsure what is right for your circumstances, consider taking regulated financial advice. The value of investments and any income received from them can fall as well as rise, and investors may receive back less than they originally invested. Past performance is not a guide to future returns.