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Working Lunch Wednesday, 29 January, 2003, 16:06 GMT
The name's bonds...
Bond diagram
A bond is a promise to pay you back

Shares are about as popular as a bacon sandwich at a vegetarians' convention at the moment.

But apart from cash, where else can you invest your money?

Well, the main alternative to shares are bonds.

They're aptly named because bonds are based on a promise that they bind the bond issuer to the purchaser.

When you buy a bond, you are lending the issuer money.

Compensated

In return, they promise to pay back the loan at an agreed date and in addition they promise to pay a fixed rate of interest.

Some promises are worth more than others.

If you are not confident that the promise will be kept, you will probably want to be compensated for the risk that the bond won't be repaid by getting a higher rate of interest.

That's exactly what happens. Well established, famous companies with good track records pay less interest on their bonds than newer bond issuers.

Cover price

A bond is issued by a company as a way of borrowing money.

For example they might issue a 100 bond paying 4 a year interest until 2005.

The company will always pay 4 - which is 4% - of the cover price.

How higher prices mean lower interest rates
But bonds can be sold. If a lot of people wanted to buy my bond paying 4%, I could probably charge a bit more - perhaps 110.

The company is still paying 4 interest but because my buyer paid a higher cover price for the bond, they are now effectively getting just 3.6% of the new price.

And there you have a very important pattern.

As the price of a bond moves up, the actual interest rate goes down.

The bondholder was getting 4% - now they are getting just 3.6%.

And that's exactly what is happening at the moment.

Disappointed by shares, there has been a big movement of money out of the stock market into the bond market.

Refuge

And as a result this is what has happened to the price.

Alan Capper, head of bond portfolios at BNP Paribas, says they can offer a refuge for people worried by the stock market.

Alan Capper, BNP Paribas
Alan Capper: "Bonds can be quite attractive"
"The volatility of returns in the corporate bond market are much lower than they are in the equity market," he says.

"And as an investor you can choose your company, your sector and your credit rating to try to minimise that risk.

"Although there is obviously some kind of parallel between equity movements and corporate spreads - we can see the correllation is quite good - you are effectively reducing your credit risk and that's why corporate bonds can be quite attractive."

But will you just be following the herd if you move into bonds now?

Exposure

"It's tempting to say you've missed the boat here," admits Alan.

"We've had such a large move in equities over the past couple of years that's a very tempting conclusion.

But he thinks there could still be openings as institutional investors realise they have too many shares and try to reduce their exposure by moving into bonds.

"Individals should follow that move over the coming years," says Alan. "Although I think it is late, better late than never."

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