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What are Bonds

Governments and companies can finance their projects and initiatives by releasing bonds. A bond is a loan that is provided by the borrower, who is the issuer, and purchased by the lender, who is the investor.

The issuer must guarantee two things to the investor: to reimburse the initial sum at the expiration date and to pay a regular interest rate, known as the coupon rate, to the lender throughout the life of the loan.

What determines the level of coupons to pay? There are a few factors to consider:

Economic conditions: The higher the predicted economic expansion and inflation, the more investors anticipate to get in the form of interest rate/return.

Investment timeframe: The interest rate is higher as the maturity period increases. Generally, investors demand a higher interest rate when they have to commit their funds for a longer period.

Risk premium: The more uncertain the likelihood of repayment for a borrower, the higher the interest rate attached to them. This is because investors need to be rewarded for taking the risk of lending money to that particular issuer.

Types of Bonds

  • Government Bonds – These are debt securities that are issued by a national government and denominated in the nation’s currency, for instance, Swiss Government Bonds. These bonds are typically viewed as having a virtually zero risk of default and are seen as one of the most secure investments, as the government can impose higher taxes or print more money to fulfill the bond’s obligations when it reaches its maturity. Bonds issued by national governments in foreign currencies are usually referred to as sovereign bonds.
  • Corporate Bonds – Companies issue corporate bonds as a method of generating money for their operations, such as enlargement or launching of new projects. Corporate bonds tend to offer higher yields than government bonds, due to their greater risk. There are various ratings for these corporate bonds, which differ depending on the financial situation of the issuers. High yield bonds are usually issued by lower quality entities and offer higher returns to balance out the higher risk of default. (Please consult the rating agency section for more information.)
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