Bonds

Bonds are debt securities that issuers (governments, companies, or other institutions) use to borrow capital from investors. They are among the traditional asset classes and play a central role in the financial world. When you buy a bond, you become a bondholder, effectively lending money to the issuer for a specific period. In return, the issuer is obligated to pay you regular interest, known as coupon payments, and to repay the face value (principal) of the bond at the end of the term

Function

A bond works according to a simple principle: the issuer issues the bond, investors purchase it and thus provide the issuer with capital. During the term, investors receive regular interest payments. At the end of the term, the issuer repays the nominal value of the bond.

Bonds can also be bought and sold before maturity on the so-called secondary market on the exchange. The price depends on supply and demand, current interest rate levels, and the issuer's creditworthiness.

In the context of bonds, one frequently encounters specific technical terms:

The nominal value (or face value) refers to the amount the issuer repays at the end of the term (maturity).
The coupon is the interest rate that the issuer pays regularly

What Are Ratings and Why Are They Important?

Ratings assess the creditworthiness (credit quality) of countries or companies that issue bonds. These ratings are assigned by independent rating agencies such as Moody’s, Standard & Poor’s, or Fitch.

A good rating (e.g., "AAA") attests that the issuer has the highest creditworthiness: The probability that it will repay its debts is very high.
A poor rating (e.g., "B" or "CCC"), conversely, warns of an increased risk of default.

For investors, an important rule of thumb applies: The worse the rating, the higher the interest rate. Issuers with weak creditworthiness must offer higher interest rates to compensate investors for the higher risk. Conversely, very secure borrowers generally pay lower interest rates.

Why Is the Maturity of a Bond Important – And How Does It Affect the Interest Rate?

The maturity describes the time span until the issuer repays the borrowed capital (maturity date). This can range from a few months to several years.

Basically, the following applies: The longer the term, the higher the risk. This is because the further the repayment date lies in the future, the more difficult it is to make forecasts. In addition to inflation and interest rate fluctuations, the risk that the issuer will face financial difficulties or even file for bankruptcy increases over the years.

To compensate for these uncertainties, issuers usually offer higher interest rates for longer terms. Short-term bonds, on the other hand, often have lower interest rates but are considered safer, as the debtor's solvency is easier to assess in the short term.

Example

Let's assume you invest CHF 1,000 in a bond with a 6-year term and a 5% coupon. This means CHF 50 in interest annually.

In years 1 through 5, you receive CHF 50 each year. At the end of the 6th year, you receive the final interest payment of CHF 50 and the repayment of the capital.

In total, you receive CHF 300 in interest over the term, while receiving your original investment (the nominal value) back in full at the end of the term.

In addition, many bonds have a minimum denomination and fixed trading increments, for example, CHF 5,000, 10,000, or 100,000.

This makes diversification difficult: With CHF 25,000 and a denomination of 10,000, you can often only buy two securities, which increases the concentration risk. Anyone wishing to invest a small amount or diversify more broadly often chooses a bond ETF or fund.

Yield

With bonds, a distinction is made between the current yield and the more meaningful Yield to Maturity (YTM).

The Current Yield is a snapshot: It simply divides the coupon by the current purchase price. It indicates the direct interest return on the money invested but ignores the fact that the bond will be repaid at 100% at the end (regardless of the purchase price).
The Yield to Maturity (YTM) is the more important metric: It considers the total return until the end of the term. This includes all coupon payments as well as the price gain or loss resulting from the difference between the purchase price and the repayment amount.

The Rule of Thumb: If the purchase price is below 100%, the YTM is higher than the coupon because you realize an additional price gain upon repayment. If the price is above 100%, the YTM is lower because you have to accept a price loss upon repayment.

Example: A bond with a CHF 1,000 nominal value, 4% coupon, and 3 years remaining term.

Scenario A (Price 95%): You buy the bond for CHF 950. The current yield is 4.21%. However, since you receive CHF 1,000 back at the end (CHF 50 price gain), the actual Yield to Maturity (YTM) is approx. 5.8%.
Scenario B (Price 103%): You pay CHF 1,030. Although you receive the coupon, you only get CHF 1,000 back at the end (CHF 30 loss). As a result, the YTM drops to only approx. 2.9%.

Issuer

The issuer is the organization that issues the bond – i.e. the debtor. This can be a state that needs money for infrastructure projects, a company that wants to finance investments, or a supranational institution such as the World Bank. There are different types of bonds. Government bonds, such as government bonds or US Treasuries, are considered particularly safe. Corporate bonds, on the other hand, often offer higher interest rates but come with a higher level of risk. A special form is convertible bonds, which can be converted into shares under certain conditions.

The issuer determines the terms of the bond, including the maturity, interest rate, repayment modalities, and currency and volume. The creditworthiness of the issuer has a significant influence on the risk and interest rate of the bond.

Advantages

Bonds have a number of advantages for investors: regular coupons offer predictable income and – if held until maturity and the issuer is solvent – the repayment of the nominal value, which makes it easier to plan for larger expenses, for example. Their price fluctuations are usually lower than those of shares; Bonds thus act as a stabiliser in the portfolio and help with diversification because they often develop differently than equities. You can choose maturities that match the target (short for closer projects, longer for longer-term goals) and choose between coupon types (fixed, variable, inflation-indexed) to better manage interest rate or purchasing power risks. Large government bonds and many corporate bonds are easily tradable (often with tight spreads), so they can usually be bought and sold quickly. In addition, bondholders have capital priority over shareholders, which increases the chance of partial repayment in the event of an emergency. Together, this results in a reasonable, easily plannable building block for a broadly diversified portfolio.

Risk

Despite their stability, bonds are not risk-free. Key risks include interest rate risk, where rising market interest rates can reduce the value of existing bonds, and credit risk, which arises from the issuer's creditworthiness. Inflation risk also plays a role, as the real yield can be reduced by rising prices. In the case of foreign currency bonds, there is also a currency risk that arises due to exchange rate fluctuations.

Below is an example of each and a note on how to limit the risk:

Interest rate risk
Interest rate risk describes the risk that the market interest rate will change after the purchase of a bond. If general interest rates rise, existing bonds with a lower fixed interest rate (coupon) become less attractive – because new bonds now offer higher interest rates (see inverse relationship).

As a result, the price of the "old" bond falls. Long-term bonds are particularly affected, as their fixed interest rate remains less competitive over a longer period of time. The longer the remaining term, the greater the price loss can be if interest rates rise.

Example: You hold a ten-year government bond with a 1.5% coupon. If the interest rate on new bonds rises to 3%, the price of your bond falls – a sale before maturity then yields less than the original purchase price.
Credit risk (credit default risk)
There is a risk that the issuer may not be able to meet its payment obligations (interest or principal repayment).

Important: The problem does not start with bankruptcy – even a downgrade of creditworthiness by rating agencies usually leads to price losses.

Example: A company’s rating is downgraded from "BBB" to "BB". The bond price falls immediately because the market now demands a higher yield for the increased risk. In the extreme case (insolvency), interest payments stop, and the repayment of the principal is jeopardized.

Therefore: Look for high quality (e.g. government bonds from stable countries or bonds with an "Investment Grade" rating). In addition, you should spread your money broadly across various issuers (diversification) to avoid being dependent on a single debtor.
Inflation risk
Rising prices reduce the purchasing power of interest payments and repayments; the real yield falls.

Example: Your coupon is 2%, inflation is 3% – in real terms, you lose around 1% of purchasing power per year, despite a positive nominal yield.

Therefore: Use inflation-linked bonds or choose maturities/coupons that are realistically higher than expected inflation.
Currency risk (for foreign currency bonds)
If you buy bonds in a foreign currency, you bear the risk of exchange rate fluctuations. If the exchange rate moves unfavorably, this can erode interest income or even result in an overall loss once the money is converted back into your home currency.

Example: As a CHF investor, you buy a US Dollar bond with a 4% coupon. If the US Dollar depreciates by 6% against the Swiss Franc during the term, the currency loss wipes out the entire interest return.

Therefore: Invest primarily in bonds denominated in your own currency (reference currency). If you wish to invest internationally, you can opt for currency-hedged funds or ETFs (often marked with the suffix "Hedged" or "CHF-Hedged").

Inverse Relationship

If market interest rates rise, the prices of bonds already issued fall – and vice versa. This inverse relationship is a fundamental principle of the bond market: if the market offers a higher interest rate, older bonds with a lower coupon lose their attractiveness and thus their value. If, on the other hand, interest rates fall, the prices of these older, higher-yielding bonds rise. The chart clearly shows this correlation – as market interest rates rise, the bond price falls.