What are bonds?

Definition of bonds

Bonds are effectively promissory notes or IOUs. When you invest in a bond, you effectively lend money to a third party, who promises to pay you interest on that money over the bond’s lifetime and then to repay your investment at the end of the bond’s life.

Typically a bond’s life will last for a number of years, during which time the investor will receive interest but can’t get their money back. The bond “matures” at the end of its life, and once a bond has matured, the investor is entitled to close the account and collect their investment back.

Bonds may have a higher or lower rate of interest depending on how risky the investment is. Particularly if a bond is linked to the stock market, then the value of a bond may fall as well as rise, and the investor may not receive back the full amount they invested when the bond matures.

Example of bonds:

Jack invests £5,000 in a 3-year bond, which is linked to the stock market.

If during that time the stock market falls overall by 2%, Jack will receive:

£5,000 - (2% x £5,000) = £4,900 when his bond matures.

If, on the other hand, the stock market rises overall by 2%, Jack will receive:

£5,000 + (2% x £5,000) = £5,100 when his bond matures.