In modern economies, organisations have two main ways to raise finance: they can sell a share of ownership in the organisation (equity), or they can borrow money (debt). A bond is the most common financial instrument used for large-scale borrowing by governments and companies.

Whether you are studying economics or business for GCSEs or A-Levels, or simply want to understand how financial markets operate, bonds are a core concept. This guide provides a structured introduction to the “fixed income” market and explains how bonds function in the real economy.

Disclaimer: Apollo Scholars does not provide financial advice. This content is for educational purposes only and is designed to help students understand economic concepts. Always seek advice from a qualified financial professional before making real-world investment decisions.

What is a bond?

In simple terms, a bond is a debt instrument. When an investor buys a bond, they are lending money to the issuer. The issuer might be a government, a local authority, or a private company.

In return for this loan, the issuer makes a legal promise to:

• Repay the original amount borrowed on a specified date, and
• Make regular interest payments to the bondholder during the life of the bond.

How do bonds work in the real economy?

Imagine a government wants to build a new high-speed rail link but does not want to increase taxes immediately. Instead, it can raise the necessary funds by issuing government (sovereign) bonds to investors.

Every bond has three key features that students should know:

• The Principal (or Face Value / Nominal Value):
  This is the amount of money borrowed, for example £1,000. It is the sum that will be repaid to the investor at the end of the bond’s life.
• The Coupon Rate:
  This is the interest rate paid on the bond, usually expressed as a percentage of the principal (for example, 5% per year).
• The Maturity Date:
  This is the date on which the bond expires and the issuer repays the principal to the investor.

What happens when an investor buys a bond?

When an investor purchases a bond at its initial issue:

• Capital is transferred:
  The investor’s money goes to the issuer, who uses it to fund spending, investment projects, or to refinance existing debt.
• The investor becomes a creditor:
  The bondholder is not an owner of the organisation. Instead, they are a lender and have a legal claim to be paid interest and repaid their capital.
• Fixed income is generated:
  The investor receives regular interest payments, known as coupons. Because these payments are usually fixed in advance, bonds are described as fixed-income securities.

What happens when an investor sells a bond?

Bonds can be traded on the secondary market after they have been issued. Their market price changes over time, mainly in response to changes in interest rates:

• If market interest rates fall:
  Older bonds with higher coupon rates become more attractive. Investors are willing to pay more than the face value for them, so the bond trades at a premium.
• If market interest rates rise:
  Older bonds with lower coupon rates become less attractive. To sell them, the price must fall below the face value, so the bond trades at a discount.

Academic note: This is known as the inverse relationship between bond prices and interest rates: when interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.

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Are bonds safer than shares (stocks)?

In general, bonds are considered lower risk than shares because of their position in the hierarchy of claims:

• Legal obligation:
  Interest payments on bonds are a contractual obligation. Dividends on shares are not guaranteed and can be reduced or cancelled.
• Priority in liquidation:
  If a company goes bankrupt, bondholders (as creditors) must be paid before shareholders receive anything.
• Greater predictability:
  As bond payments are fixed in advance, bonds usually show less price volatility than shares.

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What types of bonds should students know?

Exam specifications typically focus on three main categories:

• Government Bonds (Gilts in the UK, Treasuries in the US):
  These are used to finance government spending. They are generally considered low risk because they are backed by the government’s ability to raise taxes or create money.
• Corporate Bonds:
  These are issued by companies to finance investment and expansion. They carry credit risk, meaning there is a possibility the company may fail to repay its debt.
• Municipal Bonds:
  These are issued by local authorities, such as cities or councils, to fund projects like schools, transport, or housing.

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Why are bonds important to study?

Bonds play a central role in the financial system and in government economic policy. For students, they provide a clear example of the relationship between risk and return:

• A government bond typically pays a low rate of interest because it is considered safe.
• A riskier company must offer a higher rate of interest to compensate investors for the chance of default.

Understanding bonds is an important step towards understanding how debt, interest rates and financial markets shape the modern global economy.