What a bond is and how it actually pays you

A bond is not an asset class. It is a contract. Someone who needs money — a government, a canton, a bank, a manufacturer — writes down a promise to pay specific amounts on specific dates, and sells that promise. You buy it. From that moment you are a lender, and everything that happens to your money follows from the terms written on the page rather than from anything the borrower's business does well.

That distinction is the whole reason bonds behave differently from shares. An equity holder owns the residual: whatever is left after everyone else is paid, forever, with no upper limit and no floor. A bondholder owns a schedule. The best possible outcome is that the schedule is honoured in full — you cannot receive more — and the worst is that it is not. This asymmetry, capped upside and real downside, shapes every analytical habit in fixed income, and it is why bond investors spend most of their time thinking about what can go wrong rather than what might go right.

The contract in four numbers

Almost every conventional bond is fully described by four things.

The issuer is who owes you. The nominal value (also called face value, par value, or principal) is the amount repaid at the end — it is an accounting reference, not what you pay. The coupon is the periodic interest, quoted as a percentage of nominal, not of your purchase price. The maturity date is when the principal comes back and the contract ends.

Take a concrete Swiss example. A corporate issuer sells a bond with CHF 10,000 nominal, a 2.5% annual coupon and five years to maturity. The cash flow schedule is fixed at issue and never changes: CHF 250 at the end of each of years one through four, then CHF 10,250 at the end of year five. Total cash received over the life: CHF 1,250 of coupons plus CHF 10,000 of principal, or CHF 11,250 against a CHF 10,000 outlay if you bought at par.

Notice what is not in that description: the price. The coupon is bolted to the nominal, so once the bond is trading in the secondary market the coupon no longer tells you what you earn. If the same bond later trades at CHF 9,400, the coupon is still CHF 250 a year, but your return is higher because you paid less for the identical schedule. That relationship — fixed cash flows, floating price — is the engine of the entire market, and the sibling lesson on price and yield takes it apart properly.

Coupon frequency and day counting vary by market and matter for cash planning. Swiss franc bonds and most euro-denominated corporate issues pay annually, typically on a 30/360 convention that treats every month as thirty days. US Treasuries and US corporates pay semi-annually on an actual/actual or 30/360 basis. Money market instruments use actual/360. These conventions are not trivia: they change the timing of cash, and therefore the compounding, and therefore the quoted yield on an otherwise identical promise.

Where the money actually comes from

There are exactly three sources of return on a conventional bond, and confusing them is the most common error among people new to the asset.

Coupon income. The contractual interest. Predictable, and the only component most people think about.

Pull to par. If you buy below nominal, the price must converge on nominal as maturity approaches, because on the final day the bond is worth exactly what the issuer repays. Buy at CHF 9,400 and hold to maturity and you collect an additional CHF 600 that has nothing to do with the coupon. Buy at CHF 10,600 and you lose CHF 600 the same way. This convergence is mechanical, not a forecast: it happens regardless of what the market does in between, provided the issuer pays.

Reinvestment of coupons. Each coupon arrives as cash and has to be put somewhere. What it earns depends on rates prevailing when it arrives, which nobody knows at purchase. Over long horizons on high-coupon bonds this is a large share of total outcome, and it is genuinely uncertain even for a default-free issuer.

The quoted yield to maturity bundles all three into a single number and, in doing so, quietly assumes every coupon is reinvested at that same yield. That assumption is almost never true. The lesson on yield measures deals with the consequences.

Clean price, dirty price and accrued interest

Bonds are quoted as a percentage of nominal — "98.40" means 98.40% of face — and the quoted figure is the clean price. It excludes interest that has accumulated since the last coupon date but has not yet been paid.

If you buy a bond with a 2.5% annual coupon 146 days after the last coupon on a 30/360 basis, roughly 146/360 of a year has elapsed, so accrued interest is about 2.5% × 0.4056 = 1.014% of nominal. On CHF 10,000 nominal that is CHF 101.39. You pay the clean price plus accrued interest — together the dirty price, or settlement amount — because the seller earned that interest and you will receive the whole coupon on the next payment date.

The convention exists so that quoted prices do not sawtooth upward through the coupon period and drop on payment day. It also means the price you see on a screen is never the amount that leaves your account.

The claim you actually own

Bonds are ranked. In a liquidation, secured creditors are paid from specific pledged assets, then senior unsecured, then subordinated, and only then equity. A bank's capital structure adds further tiers — senior preferred, senior non-preferred, Tier 2, and Additional Tier 1 instruments that can be written down or converted while the bank is still operating. The ladder holds only to the extent the contract and the applicable resolution regime say it does, which is why the sibling lesson on callable, convertible and structured features spends its time in the prospectus rather than in the ranking diagram. Read where you sit before assuming you sit above equity in every scenario.

There is also the question of what form the claim takes. A Swiss investor almost never holds a paper certificate. Bonds bought through a bank are intermediated securities (Bucheffekten) under the Federal Intermediated Securities Act, in force since 2010: a book entry credited to your securities account and held through a custody chain, segregated from the custodian's own assets rather than forming part of them, which is the reason a custodian's insolvency is not automatically your loss. Since the DLT Act amendments took effect in 2021, Swiss law also recognises ledger-based securities (Registerwertrechte) in the Code of Obligations, so a bond can be issued and transferred directly on a distributed ledger, with the register performing the function the certificate used to. Neither form changes the economics of the promise. Both change the list of institutions that have to keep working for you to be paid.

Alongside seniority sit covenants — contractual promises about leverage, asset sales, additional borrowing or change of control. Investment-grade covenants are typically light; high-yield covenants are elaborate, because that is where the protection has to be written down rather than assumed. Covenants do not prevent losses. They give you a legal trigger before the situation deteriorates further, which is worth something and is not worth everything.

Buying one as a Swiss investor

CHF bonds list on SIX Swiss Exchange, but the secondary market is largely dealer-driven rather than order-book driven: liquidity is thinner than in equities, and the spread between what a dealer will buy and sell at is a real cost. Minimum denominations are frequently CHF 5,000 and sometimes far larger, which puts individual issues out of practical reach for a small allocation and pushes most private investors into funds or ETFs.

Two Swiss frictions are worth knowing before you place a trade. Secondary-market purchases through a Swiss securities dealer attract the federal transfer stamp duty (Umsatzabgabe) of 0.15% on Swiss securities and 0.30% on foreign securities, split between the two parties, so roughly 0.075% or 0.15% per side. Instruments with a residual maturity under twelve months are exempt, and new issues are not subject to it. Second, the issuance stamp duty on debt was abolished in 2012, so primary issuance is clean.

What the Swiss tax system does to your coupon

This is where Swiss residents diverge sharply from the textbook, and it changes which bonds are sensible to hold in a taxable account.

Interest on bonds issued by Swiss-resident borrowers is subject to the federal withholding tax (Verrechnungssteuer) at 35%. You receive 65% in cash and reclaim the rest by declaring the holding in your securities schedule with the annual tax return. It is a cash-flow cost and a paperwork cost, not a permanent one, for a correctly declaring resident. A reform that would have abolished this withholding on new domestic bond interest was rejected by voters in a federal referendum in September 2022, so the regime stands.

The reclaim is a procedure, not an automatic credit. You list the bond and its gross interest in the securities schedule (Wertschriftenverzeichnis) attached to your return, and the refund is either set off against the tax bill or paid out. Two things follow from that. The refund arrives a year or more after the coupon did, so a portfolio built for cash flow is running a permanent interest-free loan to the Confederation on 35% of its income. And the right to the refund is not open-ended: it lapses if the claim is not made within three years of the end of the year in which the interest fell due. Interest that never reaches the return is not merely untaxed — the 35% is simply kept.

Coupon interest is then taxed as ordinary income, and where you live decides how much. Federal income tax is uniform across the country and is the smaller part of the bill. Each canton sets its own tariff on top of it, and each commune applies its own multiplier (Steuerfuss) on top of that, so the combined top marginal rate on ordinary income differs by well over ten percentage points between the lightest and the heaviest Swiss communes. The same CHF 1,000 coupon from the same bond is therefore worth visibly different amounts to two investors a train ride apart. Bond yields are small enough that this is not a rounding error: for a franc bond portfolio, the cantonal and communal rate you happen to sit under can move the after-tax return more than most decisions about which bonds to buy.

Finally, bonds count toward cantonal wealth tax at market value. In a low-yield environment a wealth tax of a few tenths of a percent can consume a large fraction of a bond's nominal income, which is a Swiss-specific reason why the arithmetic of "safe income" looks different here than in a jurisdiction without one.

What to take away

• A bond is a fixed schedule of promised payments, so the analytical question is never "how much might this earn" but "how likely is this schedule to be honoured, and what am I paying for it".
• Your return comes from three separate sources — coupon, convergence of price to par, and reinvestment of coupons — and only the first is genuinely certain even for a default-free issuer.
• The quoted clean price excludes accrued interest; the amount actually debited is the dirty price, and the gap can be over a full percent of nominal just before a coupon date.
• Seniority is contractual rather than natural, and so is the form of the claim: what a Swiss investor owns is a book entry under the Intermediated Securities Act, or in newer issues a ledger-based security under the Code of Obligations.
• Swiss withholding tax is a cash-flow and paperwork cost rather than a permanent one, but the refund has to be claimed within three years, and the income tax that follows depends on the canton and commune you live in as much as on the bond you bought.

Sources

• Frank J. Fabozzi, Bond Markets, Analysis, and Strategies — standard reference on instrument mechanics, day-count conventions and accrued interest.
• Bruce Tuckman and Angel Serrat, Fixed Income Securities: Tools for Today's Markets — rigorous treatment of pricing conventions and market structure.
• Sidney Homer and Richard Sylla, A History of Interest Rates — long-run context for what lending has actually paid across centuries.
• Swiss Federal Tax Administration (ESTV/AFC) — guidance on Verrechnungssteuer and its refund procedure, and on the Umsatzabgabe.
• Swiss Federal Finance Administration (EFV) — documentation on Confederation bond issuance and auction procedure.
• SIX Swiss Exchange — listing rules and trading conventions for CHF-denominated bonds.
• Federal Act on Intermediated Securities (BEG/FISA), and the DLT Act amendments to the Code of Obligations introducing ledger-based securities (Registerwertrechte).
• Bank for International Settlements, Quarterly Review — recurring analysis of primary issuance, covenant quality and corporate credit market structure.