How Do Bonds Work?

Video Transcript

"Hello, my name is Mark Griffith. This is a very short introduction into how bonds work. A lot of people don't really understand what a bond is. A bond is simply a way of borrowing money or lending money. The difference between borrowing money from the bank and borrowing the money by issuing bonds is that, with bonds, the loan is broke, broken up into little chunks which can be traded. So, for example, if a large company wants to borrow two million pounds, it can do that by, for example, issuing two thousand bonds each of which is worth a thousand pounds. If you buy a bond, the bond will have written into it an interest rate which you will receive each year for a certain period so there are twenty year bonds. There are ten year bonds. There are fifteen year bonds and so on. At the end of the time period, you get your money back and meanwhile, you've also received the interest rate each year. So, on the face of it, bonds are pretty safe. However, companies sometimes go bankrupt or collapse in other ways, and even governments default on their bonds. There are only two countries, in the world, at the moment, who have never, yet, defaulted on a government bond. One is the United States and the other is Britain in the United Kingdom. So, there is always a risk attached. There are organizations called credit rating agencies, and these organizations look at different companies and look at different banks and they try to assess how risky they are. Now, for example, these companies like Dunn and Bradstreet or Fitch or S and P, and you can find out how risky the bond that you've attained is, and then you'll know what your chances are that the company or the government sometimes will simply default before the bond is up. But most of the time, you get your principal back, and you get the interest for the period of the loan. So, bonds are usually considered relatively safe. They're traded, however, which means that there's also value to simply having the bond and reselling it back into the market, and that moves up and down in relation to the interest rate of the day. So, it's a little bit more complicated that it looks, but essentially it's a way of lending a company or government a big chunk of money. You get an agreed interest rate each year, and then after a certain number of years which is in the agreement, you get your principal back. As ever, good luck."