Fixed interest securities – gilts and corporate bonds
Fixed interest securities are a way for companies or governments to raise money by borrowing money from investors. Securities issued by the UK Government are also called ‘gilts’ or ‘gilt-edged securities’, while securities issued by companies are known as corporate bonds.
When might fixed interest securities be for you?
Did you know?
Fixed interest securities are also known as:
- Loan stocks
- Debt securities
Fixed interest securities might be suitable as part of a mix with other types of investment, in order to adjust the overall amount of risk you’re taking.
- Investing in gilts is generally considered to be less risky than shares. There might be more risk with corporate bonds, though they are generally still considered less risky than shares.
- However, fixed interest securities are more likely than shares to be affected by inflation (and changes in interest rates) and there might be credit/default risks if you choose corporate bonds or non-UK government bonds.
Fixed interest securities might also be suitable if you want to invest a lump sum to provide you with income.
Most fixed interest securities provide a regular, stable income from their interest payments.
If you don’t understand a financial product get independent financial advice before you buy.
The interest rate, price and other details for a fixed interest security are described using a standardised unit, called the nominal (or par) value.
This is typically £100.
A fixed interest security is basically a loan to the government or a company.
With most, you get interest payments for as long as you hold the security.
The amount of interest you will get (called the coupon) is expressed as a percentage of the nominal value.
Since the nominal value is typically £100, if a security has a coupon of 6%, you will get £6 a year interest for each nominal unit (£100) of stock that you have.
The interest provides you with a fixed amount at regular intervals.
So this is usually a very predictable way of getting an income from your investment – however, see the information below under ‘Risk’.
Getting your money back
If you hold a fixed interest security to the end of its term, you should get back the nominal value.
For example, if the term has 10 years to go and the nominal value is £100 then at the end of 10 years, you would get £100 for each nominal unit of the security that you have.
Some fixed income securities have no end date.
But you don’t have to hold a security for its whole term, because you can buy and sell fixed-interest securities on the stock market.
In this case, the amount you get back will be the market price not the nominal value.
If the nominal value or market price that you get back is higher than the amount you paid, you’ll make a gain (profit).
If it’s lower, you’ll make a loss.
The market price of a fixed interest security
Even if you buy a security when it is issued, you probably won’t pay the nominal value for it.
This is because you’ll usually buy a bond on the open market, after it has been issued, where its price can vary from day to day.
Similarly, if you sell on the open market, you get whatever the market price is at that time.
The market price quoted is the amount you would get or pay for the standard nominal unit.
But you can buy and sell in multiples or fractions of the nominal unit.
The market price you pay, or sell at, can be more or less than the nominal value for a number of reason:
- Market prices change when general interest rates change. If a security’s fixed interest rate (coupon) is higher than the return generally available on other investments like savings or shares, the security’s price will go up. If the rate is below the return on competing investments, its price will go down.
- If a credit ratings agency changes its opinion of an issuer (see ‘Risk’ below), the price of the issuer’s fixed interest securities changes. Credit ratings agencies work out the risk of a company or government not paying back its debt and then rate its securities accordingly. The highest rating is usually ‘AAA’ and the lowest is ‘C’ or ‘D’.
- If inflation goes up, prices generally go down because the future fixed interest payments will be worth less in real terms, and because higher inflation creates an expectation of higher general interest rates.
- As a security nears the end of its term, its market value will get closer to its nominal value because there is greater certainty about short term interest rates, the number of interest rate payments is reducing and there is less risk of default in the time left on the security.
- Corporate securities are generally less risky than shares but if a company runs into difficulties it might not be able to make the interest payments or pay back your money at the end of the term – you could lose the whole amount invested.
- Changes in interest rates can result in a fall (or rise) in the capital value of your investment.
- Some companies will issue a number of securities, which, if the company runs into financial difficulty, might have different levels of priority in the payments that the company is obliged to make.
- It’s a good idea to invest in securities from a number of different companies so that your investment isn’t tied to the fortunes of one company.
Government securities are usually considered safest because countries are more financially secure.
UK government securities are considered very safe – but this means the return they give you is usually relatively low.
Be aware however, there have been cases of countries being unable to meet payments.
Some large corporations in fact have better credit ratings than some overseas (non-UK) governments.
Most countries and companies have a credit rating, with a higher credit rating indicating less risk of default.
Often those with low credit ratings will offer higher interest to attract investors, but are more risky.
Specialist credit ratings agencies work out these ratings, but they are only opinions and are not guarantees.
Because fixed interest securities usually pay a fixed amount of interest and pay back a fixed nominal value, the buying power of your return falls as prices rise.
So generally fixed interest securities are not a good choice if you’re worried about inflation.
However, some government securities and some corporate bonds are index-linked, which means that both their interest and nominal value are increased in line with prices.
How to buy fixed interest securities
- Corporate bonds can be bought for you in the market by a stockbroker who will charge a fee. A financial adviser or investment manager will also go through a stockbroker.
- Many corporate bonds are bought and sold in very large minimum amounts. But some, called retail bonds, can be bought and sold in much smaller units designed to be suitable for private investors.
Newly issued gilts can be bought from the UK government’s Debt Management Office, although there are a number of steps to follow.
Investing in fixed interest securities through a pooled or collective fund
In a pooled fund, you and others put money into a fund and the fund manager buys and sells fixed interest securities.
- Because the fund is constantly buying and selling securities, there’s no date on which your investments mature.
- You choose your fund according to your risk profile – normally a fund that comes with less risk means a lower return too.
- There’s usually a fee taken from your returns to pay the fund management company.
Find out as much as you can about the fixed interest securities or fund you’re interested in through your own research or by taking professional advice.
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