A bond is a loan from an investor to a borrower - typically a government, government agency, or corporation. The borrower promises to pay the investor a fixed rate of interest (the coupon) at regular intervals (usually semi-annually) and to repay the original loan amount (the face value or par value) at a specified future date (the maturity date). In return for lending money, the investor receives predictable income and, assuming the borrower does not default, the return of their capital.

The key feature that distinguishes bonds from shares is that the income is contractually specified in advance. A bond with a face value of $1,000 and a 5% coupon pays $50 per year regardless of how the economy or the borrower's share price performs. This predictability is the source of bonds' stability in portfolios - and also their main limitation in high-inflation environments where fixed returns erode in real terms.

Not all bonds carry the same risk or return profile:

• Australian Government Bonds (AGBs): Issued by the Commonwealth of Australia, the highest credit quality available domestically. Considered effectively risk-free for default purposes. Pay semi-annual coupons. Traded on the ASX under the 'exchange-traded Treasury bond' (eTB) platform and available through brokers. Yields track the RBA cash rate and inflation expectations.
• State government bonds (semi-government bonds): Issued by state governments (NSW TCorp, QTC, WATC, etc.). Slightly higher yield than Commonwealth bonds but still very high credit quality. Generally not directly accessible to retail investors without a bond broker, though available indirectly through bond ETFs.
• Corporate bonds: Issued by companies to raise debt capital. Higher yield than government bonds to compensate for default risk - a company can fail to make coupon payments or repay principal. Investment-grade corporate bonds (rated BBB- or above by S&P, Baa3 or above by Moody's) carry relatively low default risk; sub-investment grade (high yield or junk) bonds offer higher yields with meaningfully higher risk.
• Floating rate bonds: Coupon payments vary with a benchmark interest rate (typically BBSW, the bank bill swap rate). Unlike fixed-rate bonds, floating rate bonds do not lose value when interest rates rise - making them useful in rising rate environments.
• Inflation-linked bonds (Treasury Indexed Bonds): Issued by the Commonwealth with face value indexed to CPI. Both the coupon and principal grow with inflation, protecting the investor's real return. Available through the ASX eTB platform.

The inverse relationship between bond prices and yields is the most important concept to grasp:

• When interest rates rise, existing bond prices fall: If you hold a bond paying 4% and new bonds are issued at 6%, your bond becomes less attractive - its price drops until the yield (effective return at the new price) equals the market rate. This is why bonds lost significant value in 2022 when central banks raised rates rapidly.
• When interest rates fall, existing bond prices rise: The reverse applies - your 4% bond becomes more valuable when new bonds only pay 2%. Price and yield move in opposite directions.
• Duration measures interest rate sensitivity: A bond's duration (measured in years) indicates how sensitive its price is to rate changes. A duration of 5 years means the bond's price will fall approximately 5% for every 1% rise in interest rates. Longer-dated bonds have higher duration and greater price sensitivity.
• Yield to maturity (YTM): The total return an investor receives if they hold the bond to maturity - incorporates the coupon payments and any gain or loss if purchased above or below face value. The most useful single metric for comparing bonds.
• Credit spread: The difference in yield between a corporate bond and an equivalent-maturity government bond. Reflects the market's assessment of default risk. Widening spreads signal increasing concern about corporate credit quality.

Retail investors can access bonds through several channels:

• ASX exchange-traded Treasury bonds (eTBs): Commonwealth government bonds traded on the ASX like shares. Accessible through any standard broker. Face value of $100 per bond. Search ASX for 'Treasury Bonds' for the current list of maturities and yields.
• Bond ETFs: The most practical option for most retail investors. A bond ETF holds a diversified basket of bonds and trades on the ASX like a share. Major options include: VAF (Vanguard Australian Fixed Interest Index ETF, MER 0.20%) tracking the Bloomberg AusBond Composite 0+ Yr Index; IAF (iShares Core Composite Bond ETF, MER 0.15%); VGB (Vanguard Australian Government Bond Index ETF, MER 0.20%) for government-only exposure; VBND (Vanguard Global Aggregate Bond Index ETF (Hedged), MER 0.20%) for global bond exposure hedged to AUD.
• Term deposits: Not technically bonds, but functionally similar - a fixed rate for a fixed term with capital guaranteed up to $250,000 per institution by the government Financial Claims Scheme. Simpler than bond ETFs and appropriate for shorter time horizons (3 months to 5 years). Returns are fully taxable as interest income.
• Bond funds through super: Many Australian super funds allocate a portion of balanced and conservative options to fixed income. If you are in a balanced or defensive super investment option, you likely already have bond exposure through the fund.

Bonds are not a growth asset - their primary role in a portfolio is stability, income, and diversification. Bonds and shares typically (though not always) move in opposite directions: during economic downturns, central banks cut interest rates (pushing bond prices up) while share prices fall. This negative correlation provides a portfolio buffer. The classic '60/40' portfolio (60% shares, 40% bonds) has historically delivered reasonable risk-adjusted returns for this reason.

In Australia, the franking credit system makes fully franked Australian share dividends particularly tax-efficient for domestic investors - partly explaining why Australian investors have historically been more equity-heavy than their international counterparts. However, for investors approaching retirement, those with lower risk tolerance, or those who need regular income, an allocation to bonds or fixed income of 20 to 40% is well-supported by portfolio theory. As a rule of thumb, many advisers suggest a bond allocation roughly equal to your age as a percentage - a 60-year-old might hold 40 to 60% in defensive assets.

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