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Back to Basics: What is a Bond?

Samuel Kemp, aged 10, asks Morningstar analyst Louise Babin about what role bonds play in an investment portfolio

Holly Black 17/10/19

Samuel Kemp: Hello, I'm Samuel Kemp. This is Louise Babin. And today, we're going to talk about bonds. Hello, Louise.

Louise Babin: Hello, Sam.

Kemp: What is a bond?

Babin: So, a bond is an agreement to lend a certain amount of money, which will pay back in a set number of years and then every year, there will be a small amount that's paid extra called interest. And the interest is supposed to compensate the lender for the risk of lending to the borrower, so the fact that they might not pay that money back in full at the end, or they might be late with some of their payments.

Kemp: So, why do companies issue bonds?

Babin: Usually to pay for big projects, so an office building like this that we're in or a factory, or they might want to do some research, develop a new product, so they can go and sell, or they might want to buy another company.

Kemp: So, can countries issue bonds, too?

Babin: They do, they issue a lot of bonds. Countries borrow a lot of money. And they use that really for things that can be for the benefit of the whole society. So, it will be schools, hospitals, roads, armies, but it will also can be payments that go to people who live in that country, so that will be pensions, or maybe child benefit, even.

Kemp: So, why is it good to invest in bonds?

Babin: The predictability is probably the key attraction for bonds, because you should know how long you need to lend the money for, how much you're going to get each year and how much you should get at the end. A lot of people appreciate that, particularly if they need the income to spend on an annual basis, or even if they just like to find out what they're expecting, say, 5 or 10 years from them.

Kemp: Very interesting. Thank you very much, Louise.

Babin: No problem.

Kemp: Goodbye.

About Author  Holly Black

Holly Black  

is Senior Editor, Morningstar.co.uk