Bond
What a bond is, how the coupon, face value and maturity work, and why bond prices fall when interest rates rise.
Key idea
When you buy a bond, you become a lender. The issuer pays you a fixed coupon on the face value and repays that face value at maturity. In between, the bond trades on the market and its price moves opposite to interest rates: when new bonds pay more, existing ones are worth less, and when rates fall, they are worth more.
What it is
A bond is a loan you make to a government or a company. In return, the issuer promises to pay you interest at fixed intervals and to repay the full amount on a set date. As a bondholder you are a creditor, not an owner: you don't share in the profits, but you get paid before shareholders if things go wrong.
Every bond comes down to three terms. The face value is the amount repaid at the end. The coupon is the yearly interest, as a percentage of face value. The maturity is the date the loan ends. Buy a CHF 1,000 bond with a 4% coupon and a 10-year maturity, and you receive CHF 40 every year for ten years, then your CHF 1,000 back. That's CHF 400 in interest on top of your original money.
Why prices move
You don't have to hold a bond until it matures. Bonds trade on the market every day, and their price moves opposite to interest rates. If new bonds start paying 6%, nobody will pay full price for your 4% bond, so its price falls until its return matches the market. If rates drop to 2%, your 4% coupon looks generous and the price rises. Here's the same 10-year, 4% bond at different market rates:
| Market Rate | Bond Price | Change |
|---|---|---|
| 2% | 1,179.65 | +18.0% |
| 3% | 1,085.30 | +8.5% |
| 4% | 1,000.00 | 0.0% |
| 5% | 922.78 | −7.7% |
| 6% | 852.80 | −14.7% |
A two-point rise in rates knocks almost 15% off the price, even though the issuer hasn't missed a single payment. The return you'd earn by buying at today's price and holding to the end is called the yield to maturity. How strongly a bond's price reacts to rate changes is its duration: bonds with long maturities and low coupons react the most.
Main types
Who issues the bond decides most of its risk and return:
Government
Issued by countries, cantons or cities. Stable issuers like the Swiss Confederation pay low interest because default risk is tiny.
Corporate
Issued by companies to fund growth or operations. They pay more than government bonds to compensate for higher default risk.
Zero-coupon
No yearly interest. You buy below face value and receive the full amount at maturity, the difference is your return.
Some bonds come with extra features. Convertible bonds can be swapped for shares of the company. Callable bonds let the issuer repay early, usually when rates have fallen, which is exactly when you'd rather keep the bond. Rating agencies like S&P, Moody's and Fitch grade issuers: bonds rated investment grade are considered safe, while high-yield bonds pay more because the risk of default is real.
The risks
Bonds are steadier than stocks, but not risk-free. Three things can hurt you:
Rising rates
When rates go up, existing bonds lose value. A problem if you need to sell before maturity.
Default
The issuer may be unable to pay interest or repay the loan. The weaker the issuer, the higher this risk.
Inflation
Fixed payments buy less as prices rise. Over ten years, inflation can quietly eat much of your return.
The honest caveat
Bonds are often called the safe part of a portfolio, and held to maturity from a solid issuer, they do return exactly what they promised. But most private investors don't hold single bonds. They hold bond funds or ETFs, which never mature. The fund keeps rolling into new bonds, so when rates rise, its price drops and there's no maturity date that brings it back to par. Bond funds can lose money, and in years of sharply rising rates they have.
That doesn't make them a bad choice. Bonds pay a steady income, usually fall less than stocks in a crash, and smooth out the ride of a portfolio. Just treat them as lower risk, not no risk, and match the maturity to when you'll actually need the money.
Swiss note
Interest from Swiss bonds is subject to 35% withholding tax, deducted before it reaches you. Swiss residents get it back by declaring the bond in their tax return. Foreign bonds avoid this but add currency risk: a solid euro or dollar coupon can disappear if the franc strengthens. Many Swiss investors choose CHF bonds or currency-hedged bond funds for that reason.
Key takeaways
- —Three terms define every bond: the face value, the coupon rate and the maturity date.
- —Bond prices move inversely to interest rates, and long-dated or low-coupon bonds react the most.
- —Yield to maturity is the annual return you earn if you buy at today's price and hold until the end.
- —Weaker credit ratings and longer maturities pay higher interest to compensate for default, rate and inflation risk.
- —Held to maturity, a bond from an issuer that does not default returns its full face value, whatever its price did along the way.
Related concepts
Yield to Maturity (YTM)
The coupon is what a bond pays. The yield is what you actually earn.
Withholding Tax
Where the missing 35% of your dividend went, and how to get it back.
Asset Class
Stocks, bonds, cash and real estate each work in their own way.
Interest Rate
How the SNB's rate reaches your savings account and your mortgage.
Risk and Return
More risk buys the chance of a higher return, not the promise.