What is it?
Fixed interest investments are basically IOUs from governments and companies. In return for lending them money, they promise to pay you a fixed rate of interest for a
fixed period of time and then repay the money you originally lent them (known as 'redemption'). Government IOUs are known as 'gilts' (a.k.a. 'treasuries' / 'sovereign debt') and those from
companies are called 'corporate bonds'.
The government wants to borrow £10 million, so it issues 10 million gilts at £1 each over 30 years paying 5% interest.
Mr Cautious buys 1,000 of these gilts for £1,000. He receives an annual income of £50 (£1,000 x 5%) for 30 years, followed by the return of his original £1,000.
Ways to get a return
The main return from fixed interest is usually income. However, if you buy or sell a gilt or bond between its issue and redemption (they can be easily traded), you
could make or lose money.
The fixed amount of interest you receive is known as the 'coupon'. In practice, most fixed interest investments quote their income as a 'yield'. The simplest version is
the 'income' yield, which is the annual coupon (i.e. interest) divided by the price of the gilt or bond. If a bond is priced at 100p and the coupon is 6p then
the income yield is 6%. This makes it easy to compare the income return to other investments and savings accounts.
The amount of coupon a government or company pays mainly depends on interest rates and the likelihood they'll be able to pay coupons and repay your money at redemption.
If you can get 5% interest in an easy access savings account then a government or company will have to offer you more than this to encourage you to tie up your money for
many years. Furthermore, if there's some doubt over their ability to pay your coupons and/or repay your money at redemption (i.e. they might 'default') they'll have to
offer a lot more interest to compensate for the potential risk. This is known as the 'risk premium'.
What types are there?
The most common types of fixed interest investment are:
GiltsIndex-Linked GiltsInvestment Grade BondsHigh Yield BondsPIBSZero Coupon
Gilts are bonds issued by the Government and traded on the London Stock Exchange. The coupon is paid in two equal instalments per year and the gilt has a specific
redemption date. Gilts are issued at a 'nominal' price of 100p.
Gilts include the coupon and redemption date in their name. For example, a Treasury 5% 7 March 2018 is a gilt that pays an annual coupon of 5p (two 2.5p payments) and
will redeem on 7 March 2018.
Because gilts are backed by the British Government they are viewed as being very secure, hence their yields are normally lower than corporate bonds.
To help investors determine the likelihood a company will default on its bond, agencies such as Moody's and Standard & Poor's provide risk ratings for many bonds.
Such agencies are certainly not infallible, but their ratings can nonetheless be useful for investors.
|Fixed Interest Ratings
||Standard & Poor's
||Upper Medium Quality
||Lower Medium Quality
|Non Investment Grade
||Danger of Default, if not already
The following applies to gilts, qualifying corporate bonds (generally non-convertible bonds issued in sterling) and PIBs:
||Coupons are paid gross, but subject to income tax which you must pay as applicable.
|Capital Gains Tax
||Capital gains are tax-free.
The yield curve
The yields on bonds tend to vary depending on the length of time until redemption. The longer the period the more yield investors are likely to want because there's
more time for things to go wrong, hence more risk (results in a 'normal' yield curve). However, the yield will also depend on whether investors think interest rates
will rise or fall in future. If it's widely believed that interest rates will fall over the next five years, we'd expect a gilt redeeming in five years to have a
lower yield than one redeeming next year (other things being equal), resulting n an 'inverted' yield curve. By taking the yields from gilts of various redemption
dates and joining the dots we get a 'yield curve'.
How can I buy fixed interest investments?
You can buy gilts, corporate bonds and PIBs through most stockbrokers. Dealing by telephone or online is usually the cheapest option, where you can expect to pay around
£10 - £15 per trade. You can also buy gilts through the Government's Debt Management Office (DMO), although their dealing costs are little different or even higher than the
more competitive stockbrokers.
You can also access fixed interest investments through funds such as unit/investment trusts and exchange traded funds (ETFs). Funds are rarely worthwhile for gilts
because managers struggle to add enough value to outweigh their fees, but can work better for corporate bonds. Funds also provide simple access to overseas fixed interest.
You can find out more about unit trusts here.
Fixed interest jargon
Click below to display some of the more common fixed interest jargon:
|Corporate Bond||IOU issued by a company. They pay a fixed rate of interest until they eventually pay back the money.
|Coupon||The interest you receive from a gilt or corporate bond.
|Credit Ratings||Ratings issed by agencies such as Standard & Poor's and Moody's that help investors determine the likelihood a company will default on its bond.
|Debt Securities||Another name for a corporate bond.
|Default||When a company is unable to pay interest and/or redemption on their bonds.
|Duration||A measure of how sensitive a bond's price is to movements in interest rates. The higher a bond's duration, the more sensitive it will be.
|Gilt||IOUs issued by the British Government. They pay a fixed rate of interest until repaying the money on an agreed date.
|Income Yield||A percentage measurement of annual bond income, also known as 'running yield'. Calculated by dividing annual interest by the bond price.
|Index-Linked Gilt||Gilts where both interest and the redemption value are linked to inflation.
|Investment Grade Bond||Corporate bond issued by a company where it's expected they'll be able to pay interest and repay the bond at redemption.
|Junk Bond||Corporate bond issued by a company where there's some doubt over their ability to pay interest and/or repay the bond at redemption.
|PIBS||Permanent Interest Bearing Shares. A type of corporate bond issued by building societies.
|Redemption Yield||A percentage measurement of annual bond income that also includes any anticipated profit or loss on the bond price between now and redemption.
|Risk Premium||The amount of extra interest companies with a less than perfect credit rating must pay on their bonds to compensate for the additional investment risk (compared to gilts).
|Sovereign Debt||IOUs issued by the governments. They pay a fixed rate of interest until repaying the money on an agreed date.
|Yield Curve||A graph that shows how the yields on bonds vary depending on the length of time until redemption.
|Zero Coupon Bond||A corporate bond that pays no interest. They're instead issed at a 'discount' price which increases over time to a redemption price.