Jasmine Birtles
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Bond markets: what are they and how do they work?
George Sweeney
30th Jun 2022
Bond markets? It may shock you to hear that this market is not somewhere that allows you to trade James Bond memorabilia, it’s a little drier.
Bonds, treasuries, and gilts all refer to pretty much the same thing. It’s basically a way for governments and businesses to issue debt.
You can then buy some of this debt and get a reward for lending your money for a period of time.
Most governments and businesses pay for things using debt. Whether that’s to pay for a war, finance a global pandemic, or access money banks aren’t willing to lend them.
Read on to find out more about the bond market.
How bonds work
Here’s the basic system that fuels the bond market:
- Someone wants to borrow money.
- You loan an amount of money to them by purchasing a bond.
- At an agreed date you are paid the original principal plus some interest.
Although a bond itself is quite simple, the bond markets are terribly complex.
There’s a global interlinking of debt between countries. Some are more credit worthy than others, and certain companies are more reliable than others.
Everyone gets a credit rating. Just like the one that gets checked when you want to take out a loan.
What makes the bond market more complicated is that there are secondary markets where these various debts can be resold.
The result is that you end up with a giant web weaved of debt. And if one strand snaps, it can lead to a tangle or a complete break in the whole web.
How to invest in the bond market
Bonds are a little different to stocks. Often, you can’t access the majority on stock exchanges, you have to buy them directly or with a specialist broker.
The main ways to buy bonds are:
- Buy directly from the government – HM Debt Management Office in the UK and from the US Treasury in America.
- Purchase savings bonds directly from a bank or building society.
- Buy corporate bonds from companies using a broker.
- Invest in collective funds such as unit trusts or open-ended investment companies (OEICS).
In practice, buying bonds from banks tends to be the most straightforward but the return won’t knock your socks off.
Government bonds like gilts tend to be very secure, but offer a low return because it’s a ‘safe’ investment.
Like with most investments, opting for a higher risk can lead to a higher reward.
So, if you buy bonds from a government or company with a lower credit rating, there’s likely a better return on offer. But, also a higher chance of default (them not paying you back).
One of the most straightforward ways to get exposure to bond markets is by using an index fund or exchange-traded fund (ETF).
You can find these bond funds available with most popular investment platforms. Like stock market funds, they allow you to invest in a whole basket of bonds instead of picking out individual ones.
This can make investing simpler and spread your risk with some diversity. But, it can also limit your potential returns.
The bottom line on bond markets
This is a key market that you should try and get a basic understanding of.
Most of the global economy runs using the stock and bond markets as giant cogs, keeping everything ticking over.
Even if you decide not to invest, brushing up on how these markets work will open your eye to what happens with money on a global scale.
If you’d like to keep up to date with the latest market movements, news, and tips – make sure you sign up for the MoneyMagpie fortnightly newsletter.
This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.
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