Understanding Bonds and Yields (Part I)

A bond is a type of investment known as a fixed-income instrument. The name itself gives away its defining feature: it delivers a fixed income to the investor over time.

If the issuer is a company, the bond is referred to as a corporate bond. If the issuer is a government, it’s called a sovereign bond. Though the issuers differ, both types of bonds function in much the same way.

All bonds share three key characteristics:

• Face Value (or Par Value)
• Coupon Rate
• Maturity Date

Face Value (or Par Value)

This is the original value of the bond — the amount the investor will be repaid at maturity. It’s a round number as $100 or 1'000 Swiss francs, depending on the market. While this value remains constant over the bond’s lifetime, the bond’s market price can fluctuate due to various factors, such as interest rate changes and market sentiment.

Coupon Rate

The coupon rate is the fixed interest payment the bondholder receives periodically — typically annually or semi-annually. For example, if a bond has a face value of $100 and pays a $5 annual coupon, its coupon rate is 5%.

Maturity Date

Every bond has a defined lifetime. It might mature in two, five, ten, twenty, thirty years, or even in a century! Upon reaching the maturity date, the issuer repays the face value to the bondholder. Some bonds, called perpetual bonds, have no maturity date — they continue paying interest indefinitely. Unlike stocks, which have no defined lifespan, bonds offer a clear investment horizon.

Now comes the slightly more complex — but crucial — part: understanding the relationship between a bond’s price and its yield.

And in bond markets, we rarely talk about price directly. Instead, we focus on yield, which is the return on investment expressed as a percentage.

Let’s use an example:

Suppose a bond with a $100 face value pays a $5 coupon per year. At issuance:

• Coupon rate = 5%
• Price = $100
• Yield = 5%

Now imagine the bond’s price falls to $95 in the market. If you buy it at that price, you still receive $5 per year. But since you paid less upfront, your yield is now higher than 5%.

Conversely, if the bond’s market price rises to $105, the $5 coupon is still paid, but your return — or yield — is lower because you paid more to get the same income.

It’s also important — and incredibly useful — to understand the different ways bond yields can be measured, as each variation tells a slightly different story about the bond’s value, performance, and potential returns. Let’s explore three of the most commonly referenced yield types: Nominal Yield, Current Yield, and Yield to Maturity (YTM).

Nominal Yield

Also called the “coupon yield,” the nominal yield the most straightforward of the three. It’s calculated by taking the annual coupon payment (the amount the bondholder receives each year from the issuer) and dividing it by the bond’s face value, also known as par value. For example, if a bond has a face value of $1,000 and pays a $50 annual coupon, its nominal yield is 5%.

Current yield

Current Yield takes things a step further by incorporating the bond’s current market price. It is calculated by dividing the annual coupon payment by the price at which the bond is currently trading. This is particularly relevant for bonds trading at a premium (above par) or a discount (below par). For example, if that same $1'000 face value bond with a $50 coupon is currently selling for $900, the current yield would be approximately 5.56%. Conversely, if it’s trading at $1'100, the current yield drops to around 4.55%.

Yield to Maturity

That brings us to the most comprehensive and widely used measure: Yield to Maturity (YTM). This yield calculation is more complex, as it considers not only the annual coupon payments and the bond’s current market price but also the time remaining until the bond matures and the difference between the purchase price and the bond’s face value at maturity.

YTM essentially represents the internal rate of return (IRR) of the bond if held to maturity — it’s the total return an investor can expect to earn, assuming they reinvest coupon payments at the same rate and hold the bond until it matures. Because YTM incorporates both income (via coupons) and capital gains or losses (depending on whether the bond was bought at a discount or premium), it offers the most complete picture of a bond’s profitability.

It provides a way to compare bonds with different prices, coupon rates, and maturities on a consistent, apples-to-apples basis. While nominal yield and current yield can be useful for quick reference or assessing income potential, YTM delivers a much deeper understanding of the bond’s total return potential over its full life. It’s the go-to metric for anyone trying to make sound, data-informed fixed income investment decisions.

Several factors affect bond prices and their yields.

1. Interest Rates

This is the single most important factor. When central banks raise interest rates, existing bonds become less attractive because new bonds offer better returns. As a result, the price of existing bonds falls and their yields rise.

2. Credit Risk

Higher-risk borrowers must offer higher yields to attract investors. A bond issued by a startup will usually have a higher coupon than one issued by a financially stable government, reflecting the higher risk of default.

3. Maturity

Longer-dated bonds generally offer higher yields than shorter-dated bonds to compensate investors for tying up their money for a longer time. This is known as the term premium.

But in regular market conditions, shorter-term bond yields are lower than their longer-term peers.

When navigating the world of fixed-income investing, it’s essential to understand the different types of bonds available, as each comes with its own risk profile, return potential and role within a diversified portfolio. Among the broad array of bond instruments, two of the most common categories are government bonds and corporate bonds. These instruments serve as the backbone of global debt markets and are routinely used by investors to generate income, preserve capital or hedge against volatility in other asset classes.

Government Bonds: Stability and Security, But Not Without Questions

Government bonds are issued by national governments to fund public spending, infrastructure projects and debt refinancing. These bonds are often seen as the most reliable and low-risk form of debt investment, particularly when issued by countries with strong, stable economies and well-established institutions. For example, government bonds from Switzerland, Germany, or the United States are typically considered ‘safe havens’ during times of market stress. They tend to offer lower yields because they carry a very low probability of default, meaning investors are highly confident they will get their money back, plus interest.

These bonds are also widely used as benchmarks in financial markets.

However, even the safest assets are not immune to scrutiny. In recent years, there has been growing concern about the long-term sustainability of sovereign debt in some advanced economies, particularly in the United States.

The sheer scale of U.S. federal debt — now exceeding $34 trillion — has prompted debates about fiscal responsibility, the risk of higher interest rates crowding out productive investment and the potential erosion of investor confidence in the long run.

Corporate Bonds: Higher Risk, Higher Reward

By contrast, corporate bonds are debt securities issued by companies to raise capital for business operations, expansion, acquisitions or refinancing existing debt. These bonds come with a higher degree of risk than government bonds — primarily due to the possibility that the issuing company may not be able to meet its financial obligations in the future. If a company experiences financial difficulty, investors holding its bonds may suffer losses or, in a worst-case scenario, fail to recoup their capital entirely.

This is especially true for bonds issued by companies without top-tier credit ratings. Even within the corporate bond universe, there is a wide spectrum of quality. At the high end, you’ll find investment-grade bonds — issued by financially sound firms like Nestlé, Microsoft or Siemens. These companies are generally considered stable and have a relatively low chance of default. Nestlé, for example, may issue a bond that offers a higher coupon than a Swiss government bond, even though both are based in the same country. The reason? Companies — even highly reputable ones — can go out of business. Countries (usually) can’t.

Further down the scale, there are high-yield or “junk” bonds, which are issued by firms with lower credit ratings. These may offer very attractive returns but come with significantly elevated default risk.

This dichotomy between government and corporate bonds highlights one of the fundamental principles in finance: the risk-return trade-off. Put simply, the greater the risk an investor is willing to accept, the higher the potential return they demand in compensation. Low-risk assets like Swiss government bonds tend to offer modest, predictable returns. Higher-risk instruments — such as corporate bonds or emerging market sovereign debt — must entice investors with higher yields to account for the added uncertainty.

It’s this dynamic that allows investors to customize their fixed-income exposure according to their risk tolerance, income needs, and macroeconomic outlook.

Bond creditworthiness is assessed by rating agencies such as:

• Moody’s
• Fitch
• Standard & Poor’s (S&P)

These agencies assign ratings based on the issuer’s financial health, ranging from AAA (highest quality) to junk status (speculative and risky).

For example:

• The U.S. government currently holds an AA+ rating from S&P.
• Apple also holds an AA+ rating — meaning the likelihood of Apple defaulting is considered comparable to that of the U.S. government.
• Switzerland holds a AAA rating, while Nestlé has a AA- rating.

You may wonder: why should I care about all this?

Bond yields are a barometer for the economy. When yields on government bonds rise, it often reflects expectations of higher inflation or tighter monetary policy. Falling yields can signal investor caution or economic slowdown.

Below is a concise guide to help you start investing in bonds, including options like trading over-the-counter (OTC) or through exchange-traded funds (ETFs).

1. Open a Brokerage Account: Use Swissquote to access a wide range of bonds. Its user-friendly interface offers tools and guides tailored for beginners. Consult here Swissquote conditions for bonds trading.

2. Choose Your Bond Type:

   • Bond ETFs: These funds bundle multiple bonds into one trade, offering instant diversification and lower risk. They’re traded like stocks, making them highly liquid and accessible with smaller investments.

   • Individual Bonds: Buy specific bonds like Swiss government bonds or U.S. Treasuries for low risk, or corporate bonds for higher yields if you’re comfortable with more risk. Minimum investments typically start at CHF 1,000.

3. Trading Options:

   • ETFs: Bond ETFs track indices like the Bloomberg Aggregate Bond Index, with low fees (expense ratios ~0.1-0.5%). They’re ideal for beginners seeking simplicity and diversification but are subject to market price fluctuations.

   • OTC Trading: Bonds are traded directly between buyers and sellers, not on an exchange. This allows customization (specific maturities or yields) but may have wider spreads and less transparency. Swissquote provides access to OTC bond markets.

4. Key Factors to Consider:

   • Credit Ratings: Check ratings on Swissquote—AAA is the safest, while lower ratings (e.g., BB) offer higher returns but more risk.

   • Maturity Dates: Choose bonds with maturities that match your goals, like saving for a home (short-term) or retirement (long-term).

   • Yields: Higher yields often come with higher risk. Review yields to ensure they align with your income needs.

   • Fees: Watch trading fees or ETF expense ratios to maximize returns. Swissquote keeps fees transparent.

Tips for Success

• Align bond choices with your financial goals and risk tolerance.

• Use Swissquote’s platform to explore its full list of available bonds and ETFs.

• Consult a financial advisor if you’re unsure about your strategy.

Our next article will explore all bond investment methods in greater detail, including advanced strategies and options.

The content in this article is provided for educational purposes only. It does not constitute investment advice, financial recommendations, or promotional material.