Bonds simply explained

Bonds, also called debentures or bonds, are securities that yield a fixed interest rate over a specified term.

What is a Bond

A bond is really nothing more than a debt between a creditor and a debtor. For most people, however, bonds are merely investments, similar to stocks. Unlike stocks, no shares in companies are bought, but only debt capital is borrowed. In return, capital providers receive interest payments. Since interest and duration are fixed, bonds are often traded as a safe alternative to stocks.

How is a Bond Created

Typically, bonds are created when companies need additional capital. For this purpose, they issue bonds, which they sell to investors over a defined term and with a defined interest rate.

The same applies to states. These are called government bonds. Especially in economically stable countries, one can assume a safe investment.

As with all investments, risk and return go hand in hand. If we buy bonds from companies with a good rating (i.e., low risk), the potential return is rather small. With companies with a bad rating (higher risk), the return is higher, on the other hand.

Bonds in Reality

Just because bonds have a fixed term and fixed interest, it does not mean that they do not adjust to market conditions. The price of a bond constantly varies, and always exactly in the opposite direction of the interest rate.

An example:

Suppose we own a bond with a face value of CHF 1,000 with a fixed coupon rate of 5% and a term of 10 years. This means that we receive interest of CHF 50 annually.

If the market interest rates now increase to 6% – that is CHF 60 interest per year, our bond becomes less attractive and the price of our bond drops. Due to the falling price of the bond, it becomes attractive again and a balance is created.