Bonds are securities that pay a fixed interest rate over a fixed period of time.
What is a bond?
A bond is nothing more than a debt between a creditor and a debtor. To most people, bonds are simply investments of capital, like shares. But unlike shares, bonds represent lending of foreign capital. In return, the lenders receive interest. Because the interest and the term are fixed, bonds are often considered a safe alternative to shares.
How a bond is created
Bonds are generally created when companies need additional capital. They do this by issuing bonds and selling them to investors for a fixed term and interest rate.
The same is true for governments. They are called government bonds. It is precisely for economically stable states that this can be considered a safe investment.
As with all investments, risk and return go hand in hand. If we buy bonds of highly rated (and therefore low risk) companies, the potential return is rather low. On the other hand, the return is higher for companies with a low rating (higher risk).
Bonds in reality
Just because bonds have a fixed duration and interest rate does not mean that they do not adapt to market conditions. The price of a bond varies constantly, and always in exactly the opposite direction to the interest rate.
Let us take an example:
Let us assume that we own a bond with a nominal value of CHF 1,000 with a fixed coupon of 5% and a maturity of 10 years. This means that we receive CHF 50 in interest each year.
If market interest rates now rise to 6% - that is, CHF 60 of interest per year - then our bond becomes less attractive and the price of our bond falls. The fall in the price of the bond in turn makes it more attractive, which creates an equilibrium.
