Bonds are one of the most well-known securities encountered not only by large investors but also by ordinary citizens. In recent years, for example, anti-inflationary bonds or the Government Bonds of the Republic have become very popular. However, you may have also come across terms such as crown bonds, bond issue or bond issuer and wondered what exactly they mean. Let us explain.
A bond is a type of security by which its issuer (technically the issuer) confirms that it has borrowed money from an investor and commits to repay it in the future. At the same time, it promises to pay the investor a certain return – usually in the form of interest. Put simply: when you buy a bond, you are making a loan to the issuer. He becomes your borrower and you become the lender.
Unlike a share, a bond does not give you an ownership interest in the company, but instead guarantees the right to receive a return of the amount invested and a predetermined return. This brings greater certainty and predictability. For example, if you buy a bond worth CZK 10,000 with an annual interest rate of 3%, you will receive CZK 300 every year for the duration of the bond. At maturity, the issuer will pay you back the original CZK 10,000.
The legal framework is governed by the Bond Act, which sets out the mandatory elements. For example, the bond must have a nominal value, maturity date, interest rate and details of the issuer. These conditions are summarised in the so-called terms of issue, which are legally binding.
Bonds thus act as a bridge between those who have spare money and those who need it. This is how the state finances its budget, companies finance new projects and municipalities finance, for example, infrastructure construction.
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In order to understand the whole process, two key concepts need to be explained: the issuer and the bond issue.
The issuer is the one who issues the bond. It can be a state, a city, a bank, or a corporation. It is actually the borrower who borrows from investors through bonds. On the other side is the investor – the lender – who buys the bond and thus provides capital to the issuer.
Bond issuance is the actual process of issuing bonds. It determines how many bonds will be issued, at what value, with what interest and when they will mature. These details are contained in the terms of issue. Under the Bond Act, the terms of issue must be clear and understandable so that investors know what they are buying.
An issue can be:
From a legal point of view, it is important that although the issuer has considerable freedom in issuing bonds, it must comply with the basic rules of the Bond Act. This is to protect retail investors from fraud and obscure issues.
State and government bonds: issued by the state, most often by the Ministry of Finance. They are among the safest because they have the whole economy behind them. They are popular among citizens looking for a stable and relatively risk-free way to save money. An example is the Czech Republic’s Bonds, known as the Republic Bonds.
Corporate bonds: these are issued by companies to finance their development, production or new projects. They usually offer a higher yield than government bonds, but also higher risk. If a company does not perform well, it may have problems repaying.
Municipal bonds: issued by cities and municipalities. They are typically used to finance public projects such as school construction or infrastructure.
Anti-inflation bonds: A special type of government bond whose yield is linked to inflation. If inflation rises, so does the investor’s return. They are very popular when prices are rising because they protect savings from depreciation.
Crown bonds: issued in Czech crowns. They were very popular in the past because of the tax advantages, as it was possible to optimise the tax liability for specific issues. Today they no longer have this function, but they have played an important role in history.
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The Czech Republic issues its own bonds, which can be purchased by citizens and institutions. The most famous example is the Republic Bond, whose different series offered different forms of appreciation – fixed interest, variable interest or an anti-inflationary variant.
The state uses bonds to finance its debt and budget needs. They represent an attractive option for citizens to invest safely. Because they are guaranteed by the State, they are among the safest investments on the market.
Specific features of government bonds:
Government bonds are also subject to clear tax rules. For example, citizens do not have to file a tax return for the proceeds of anti-inflation bonds, as the tax is already withheld at source. This simplifies their holding.
Bonds are often described as a stable and relatively safe investment instrument, but they do carry certain risks. Their main advantage is their predictability – the investor knows in advance what regular return he can expect and is therefore assured of a fixed income. At the same time, bonds allow diversification of the investment portfolio, i.e. spreading the risk among several different types of assets. In particular, government bonds are very popular and are considered one of the safest investments because the government and its economy are behind them. Their simplicity also contributes to their attractiveness – unlike equities or more complex financial products, there is no need to follow daily developments on the stock market or financial markets.
On the other hand, there are also risks to bear in mind. In the case of corporate bonds, the investor is exposed to the possibility that the issuer, i.e. the company, will not be able to repay its obligations, which may lead to a loss of the entire investment. Even with government bonds, the investor is not guaranteed to make a profit, because if the yield is fixed, inflation can easily devalue it – the real purchasing power of the money raised is thus reduced. In the case of foreign bonds, exchange rate risk, i.e. fluctuations in exchange rates, also plays a role and can significantly affect the final outcome of the investment.
While the Bond Act provides some protection for investors and sets rules for bond issues, the final decision on who to entrust their money to is always up to the individual. Therefore, it is wise to choose rather proven issuers and to read carefully the terms of issue, which specify exactly how the bond will work and what rights it gives the investor.
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The Bond Act sets out the basic rules for issuing and holding bonds. It regulates, among other things:
The law serves primarily to protect investors, so that they can be sure that a bond is not just a promise on paper, but an obligation enforceable in court. In practice, this means that if the issuer fails to pay, the investor can enforce its rights through the courts.
Bonds are securities that operate on the principle of a loan – the investor provides the issuer, i.e. a state, municipality, bank or company, with money and the issuer agrees to repay it at a specified time together with an agreed return, usually in the form of interest. Unlike shares, bonds do not create an ownership interest in the company, but provide security of repayment and predictable income. The issuance process, known as bond issuance, is subject to clear rules which require, for example, the indication of the nominal value, maturity, interest and information about the issuer; in addition, a prospectus approved by the Czech National Bank is required for public issues. There are several types of bonds – state and government bonds, considered to be the safest, corporate bonds with higher yields and risk, municipal bonds designed to finance public projects, special anti-inflationary bonds to protect savings against price increases, and crown bonds, which were popular in the past because of their tax advantages. In the Czech Republic, the best known are the State Bonds of the Republic, which citizens can easily purchase and which are guaranteed by the state. Bonds have the advantage of a regular yield, simplicity and the possibility of portfolio diversification, while their weakness is the risk of default in corporate issues, the depreciation of yields by inflation or the exchange rate risk in foreign issues
A bond is a loan to the issuer, while a share represents ownership of part of a company.
Yes, because the state is behind them, the risk is minimal.
If inflation is rising, clearly yes – it protects your savings.
They have been used for tax optimisation, which is why they have aroused a great public debate.
Bond yields are subject to taxation, with government bonds usually having the tax deducted at source.
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