All about bonds
Bonds
The other main asset class is Bonds, either Government Bonds (Gilts) or Corporate Bonds issued by our leading companies.
Gilts
Conventional Gilts carry a fixed coupon and a known price at redemption (usually par, i.e. £100). The advantage of Gilts is that they can offer a more attractive rate of return than a Building Society deposit account but again the risks must be considered.
1) Security of capital - because Gilts are issued by the government they are the safest of all investments in that respect, as the default risk is negligible.top
2) Price fluctuation - the risk with Gilts lies in the price fluctuation. Although a bond may be issued at par (100) and redeemed at par (100) for a fixed period (say 10 years) the price can fluctuate in the meantime. Complete security of capital invested can only be guaranteed if the bond is held to maturity.
3) Tax treatment - the income received is taxed at source (25%) and higher rate taxpayers are required to make up the difference at the end of the tax year. Capital gains are not subject to tax (up to a large limit) for private investors, but this is a two edged sword. As with all investments that promise freedom from capital gains tax losses are non-allowable.top
Corporate Bonds
These are similar to Gilts, but with a higher default risk. Companies can go bust unlike the government. To compensate for this higher risk a higher return is available in the form of a higher yield. Bonds are graded as to their safety. G7 Government Bonds are all AAA, as are some "Supra Nationals" such as the World Bank and European Investment Bank. Next in line are AA Bonds, usually issued by large companies, and so on. The Bonds are graded by Rating Agencies such as Moody's or Standard and Poors, and the ratings can change up and own during the life of the Bond. Many Institutions are prevented from owing bonds below the AA rating. A further problem with Corporate Bonds is marketability. Whilst a healthy two-way market exists in the mainstream Government Bonds, this is not always the case for Corporate Bonds, which can be difficult to buy or sell during the life of the bond. Tax treatment is also less favorable than for Gilts, although this is equalized via the higher yield. Corporate Bonds therefore carry greater risk but offer greater return than Government Bonds.top
Index linked Bonds (Gilts)
These are Bonds issued mainly by the Government that do not pay a fixed coupon. Instead the "Start up coupon" is increased in line with inflation over the life of the bond. Also the proceeds on redemption are calculated to deliver full index linking over the life of the Bond. The main difference between conventional and index linked bonds are as follows;
1) The income stream on index linked Gilts is not predetermined, as we do not know the future rate of inflation, whereas with conventional Gilts the exact amount is known in advance.
2) The Redemption value is also not known for [next page]