Learn Part 2 — Asset Classes Bonds — Lending Your Money

Part 2 — Asset Classes

Chapter 6 of 40

Bonds — Lending Your Money

Government bonds, corporate bonds, yield — the reliable friend nobody talks about

8 min read Beginner

"A bond is a loan you make to a government or company. They pay you interest for a fixed period, then return your money. It is less exciting than stocks. That is the point."

For educational purposes only. Nothing in this chapter is financial advice. All figures are illustrative examples. Tax rules, account types, contribution limits, and regulations differ by country and change over time. Always verify current rules with official government sources or a qualified financial adviser before making any investment decisions.

What Is a Bond?

A bond is a loan. You lend money to a government or company. In return, they pay you a fixed rate of interest (called the coupon) for a set period, then return your original amount (the principal) at the end (the maturity date).

Example: the UK government issues a bond with a face value of £1,000, a 4% coupon, and a 10-year maturity. You buy it. Every year you receive £40. After 10 years, you receive your £1,000 back. Total return: £400 in interest plus your original £1,000.

Bond anatomy

Face value / Par

The amount borrowed — what the bond pays back at maturity. Typically £1,000 or $1,000.

Coupon

The annual interest rate, expressed as a % of face value. A 4% coupon on £1,000 pays £40/year.

Maturity date

When the borrower returns the face value. Can range from 3 months to 30+ years.

Yield

The actual return you get — which differs from the coupon if you bought the bond above or below face value.

Credit rating

An independent assessment of the borrower's ability to repay. AAA is safest. Below BBB- is junk.

The Price-Yield Relationship

This confuses almost everyone the first time. When bond prices rise, yields fall. When bond prices fall, yields rise. They move in opposite directions — always.

Here is why. The coupon is fixed. If you paid £1,000 for a bond paying £40/year, your yield is 4%. If interest rates rise and new bonds now pay 5%, your old bond paying £40 is less attractive. Its price falls to roughly £800, so that the £40 coupon now represents a 5% yield on the new lower price. The payment never changed — only the price, to match the new market rate.

Same £40 coupon — different prices, different yields

Price £800

5.0% yield

Price £900

4.4% yield

Price £1,000

4.0% yield

Price £1,100

3.6% yield

Price £1,200

3.3% yield

All on the same bond paying £40/year — only the price (and therefore yield) changes.

This is why bonds fall in value when interest rates rise. The 2022 bond crash — the worst in 40 years — happened because central banks raised rates from near zero to 4-5% in 18 months. Existing bonds had to reprice sharply downward to compete with new higher-yielding bonds.

Government vs Corporate Bonds

🏛️ Government Bonds

UK: called Gilts. US: called Treasuries.
Lowest risk — governments can raise taxes or print money
Lower yields as a result
Used as the "risk-free rate" in finance
UK 10-year gilt currently ~4.2%. US 10-year Treasury ~4.4%.

🏢 Corporate Bonds

Issued by companies to raise money without diluting shareholders
Higher risk — companies can default
Higher yields to compensate
Investment grade (BBB- and above) vs high-yield / junk (below BBB-)
Typical spread over government: 0.5% (IG) to 5%+ (junk)

Why Bonds Belong in a Portfolio

Bonds have historically moved in the opposite direction to stocks during market crises. When stocks crash, investors flee to the safety of government bonds, pushing bond prices up. This negative correlation is what makes bonds valuable in a portfolio — not just their yield, but their role as a shock absorber.

A classic 60/40 portfolio (60% stocks, 40% bonds) has historically delivered roughly 80% of the returns of a 100% stock portfolio with about half the volatility. For investors who cannot tolerate watching their portfolio fall 40-50% in a crash, bonds are what lets them stay invested instead of panic-selling.

When to own more bonds

Closer to retirement — you have less time to recover from a stock crash
Lower risk tolerance — you would sell stocks in a panic but would hold bonds
Specific spending goal within 3-5 years — you cannot afford to wait for a recovery

Questions People Actually Ask

Are bonds safe?

Government bonds from stable economies (UK, US, Germany) are among the safest investments in existence — the risk of non-repayment is minimal. Corporate bonds carry more risk. High-yield (junk) bonds can be quite risky. And all bonds carry interest rate risk — if rates rise, the market value of your bond falls, even if you eventually get your money back at maturity.

What is a bond ETF?

A bond ETF holds many bonds simultaneously. Instead of buying a single government bond, you buy a fund that holds hundreds of them. This gives you diversification, liquidity (you can sell any day the market is open), and simplicity. Examples: iShares Core UK Gilts ETF (IGLT), Vanguard Total Bond Market ETF (BND) in the US.

Why did bonds crash in 2022?

Interest rates rose from near-zero to 4-5% in roughly 18 months — the fastest rate-hiking cycle in decades. Existing bonds with lower coupons had to fall in price to match the new higher yields available on fresh bonds. The Bloomberg Global Aggregate Bond Index fell roughly 16% in 2022 — a historic loss for what was considered a safe asset.

What is the yield curve?

The yield curve shows yields across different bond maturities — from 3-month to 30-year. Normally, longer bonds pay more (more time = more uncertainty = more reward). When short-term yields are higher than long-term yields, the curve is "inverted" — this has historically preceded recessions, because it means markets expect rates to fall (i.e. economic weakness) in the future.

Can I buy UK government bonds directly?

Yes. UK gilts can be purchased directly through the UK Debt Management Office (gilts.gov.uk) or through a broker. However, for most investors, a gilt ETF is simpler, more flexible, and offers instant diversification across maturities.

What is duration?

Duration measures how sensitive a bond's price is to interest rate changes. A bond with a duration of 10 years will fall roughly 10% if interest rates rise by 1%. Longer-maturity bonds have higher duration and are more sensitive to rate changes. Short-dated bonds (under 5 years) are much less affected by rate moves.

What happens if I need to sell a bond before maturity?

You can sell most bonds in a secondary market, but the price you receive will depend on current interest rates. If rates have risen since you bought the bond, you will receive less than face value. If rates have fallen, you can sell for more. Only holding to maturity guarantees you receive exactly the face value plus all coupons.

Key Takeaways

A bond is a loan — you lend money to a government or company, receive fixed interest payments, and get your principal back at maturity.
Bond prices and yields move in opposite directions — when interest rates rise, existing bond prices fall.
Government bonds (Gilts, Treasuries) are lower risk and lower yield. Corporate bonds pay more but carry default risk.
Bonds reduce portfolio volatility because they historically move opposite to stocks in crises — this is their main value for most investors.
Credit ratings (AAA → junk) indicate the borrower's ability to repay. Investment grade means BBB- or above.