Bonds are debt issued (sold) by a gov-ernment because the revenue it collects from taxation is insufficient to cover its spending, meaning it has a fiscal (or budget) deficit. When a government issues bonds (in the UK they are called gilts), they add to the outstanding public debt still to be paid off — the national debt. The bonds issued by the UK government are usually due to be repaid in 5 to 15 years and holders of bonds receive interest each year — this is called the coupon rate. A bond holder could keep the bond until it matures after say 10 years, at which point the government pays back the money it borrowed to the bond holder, having also paid interest each year.
It is also possible for the original purchaser to sell the bond to someone else before it matures via the second-hand bond market. The new purchaser will now receive the interest each year and will get the final repayment when the bond matures. It is the current second-hand market price of the bond that determines the percentage yield. The yield on government debt is a key indicator of the long-term interest rate in an economy. This is important for large companies borrowing in the corporate bond market and must not be confused with the short-term interest rate set by the Monetary Policy Committee of the Bank of England to control the rate of inflation. To understand bond yields, below are two examples.
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