The bond market offers something for every taste, but investors need to find the right balance between risk and return

The Estonian state, local banks and companies have all started issuing bonds more actively to local investors. Recent bond offerings have shown that interest remains high and shows no signs of fading. In the past month alone, investors have been able to participate in several bond issues with different profiles through the Tallinn Stock Exchange, ranging from real estate developers and entertainment businesses to banks.

In essence, a bond is a simple transaction. The investor lends money to the issuer for a fixed period and receives an agreed interest payment in return. The difference compared with ordinary lending is that the transaction is securitised: the investor and the borrower do not meet directly, there are often hundreds or thousands of lenders instead of one, and the security can generally also be sold before maturity.

Thanks to greater interest from both companies and investors, today’s bond market has also become much more layered. At the same time, the market offers both riskier high yield bonds and significantly lower risk bonds with lower returns. This means that investors need to pay even closer attention to the details of each investment.

Behind the single term “bond” are instruments with very different levels of quality, risk and liquidity. At one end are government bonds, where payment risk is generally considered low and where the return is therefore more modest.

Slightly riskier are bank senior bonds, where in the event of liquidation, claims are satisfied after depositors but before subordinated liabilities. The risk levels are also generally lower there, although the exact level of risk depends on the bank’s credit rating.

Bank Tier 2 subordinated bonds carry a higher risk than senior bonds, because in the event of liquidation, claims related to these bonds are satisfied after depositors and senior bonds. At the same time, they rank ahead of AT1 bonds and shareholders’ claims.

Bank AT1 bonds, as well as secured and unsecured corporate bonds, carry significantly higher risk. In the case of the latter two, however, the risk level and therefore also the return depend on the specific company.

Investors can also influence the return themselves

To calculate the actual return of a bond, one must look at the coupon rate, the purchase price and the time until redemption. If a bond is bought below its nominal value, the investor’s return increases. Buying at a premium, meaning above nominal value, reduces the return. It is therefore important to distinguish between the coupon rate and the actual return.

Yield to maturity, or YTM, shows how much an investor earns on average if they hold the bond until maturity, taking into account both interest payments and repayment of the principal. If the bond can be called earlier, yield to call, or YTC, also becomes important. This reflects the actual return in a situation where the investment ends earlier than expected, sometimes even at a higher level if the buyback takes place at a premium.

For example, the 4% bond of the Republic of Estonia maturing in 2032 is trading above its nominal price, and the yield to maturity based on the market price is approximately 3.3%. The yield on banks’ Tier 2 bonds is currently around 5 to 6.25%. For example, the coupon rate of Coop Pank’s bond maturing in 2032 was at 5% in March 2026, and trading at around 99% of its value, meaning the yield to call was about 6%. Coop Pank’s most recent bond issue, however, was carried out with a coupon rate of 6.25%. Since the bond was offered at nominal value during the issue, the actual return is also the same.

Recent offerings of secured and unsecured corporate bonds have been at around 7 to 10%.

Investors must be prepared for the possibility that they may not always get back the money they invested

Bonds are often accompanied by the mistaken assumption that the invested amount is always protected, but the reality is more nuanced. If a bond is sold before maturity, its price depends primarily on market interest rates and demand. When interest rates rise, bonds with a lower coupon often have to be sold at a discount, while falling interest rates may allow a bond with a higher coupon to be sold at a profit.

Holding a bond until maturity is not an absolute guarantee either. If the issuer runs into payment difficulties, the investor may not get the full principal back. Both companies and countries can go bankrupt.

In addition, with bonds it is worth taking into account the call right, which gives the issuer the option to buy back the bond before maturity. This means that the actual investment period may turn out to be shorter than expected, for example five years instead of ten.

The quality of a bond investment is determined by three main factors

When making an investment decision, investors should not look only at the coupon rate or the name of the issuer. Several connected aspects should be assessed. At the centre of it all is risk. The key question is how likely it is that the investor will get their money back together with interest.

If the goal is to preserve capital, higher risk bonds are not suitable for a conservative investor, for example unsecured bonds or bonds issued by companies in an early stage of development. An issuer with a credit rating, such as a state or a bank, gives the investor greater confidence, although risks can never be completely ruled out even in these cases.

Collateral also plays an important role in determining the risk profile, especially in the case of corporate bonds. It is therefore always worth checking what the collateral actually is. In some cases, the collateral may be formal, such as the issuer’s own shares, which may not in reality significantly reduce the investor’s risk. For this reason, the investor must be able to distinguish between real and apparent collateral and assess how much it actually helps to reduce risk.

Liquidity goes hand in hand with risk and determines how easy it is to exit the investment before maturity if necessary. One advantage of bonds is that they can be sold on the market, but this works only if there are enough buyers. In the case of smaller issues, liquidity may turn out to be only apparent. The security may be listed, but carrying out an actual transaction can be difficult or possible only by making concessions on the price.

Return is, of course, what attracts investors to bonds, but it cannot be viewed in isolation. A higher interest rate almost always means higher risk, which is why it is important to compare instruments with a similar level of risk. For example, it does not say much to compare the coupon rate of a bank senior bond with that of a real estate developer’s bond. It is more important to understand the type of bond, the issuer’s business and the level of risk.

Investing in bonds may at first seem simpler and safer than dealing with shares, but in reality thorough analysis is also needed here in order to find suitable investments.

In the current interest rate environment, bonds can offer suitable choices for investors who value both lower and higher risk and are looking for different levels of return.

It is important that, with so many bond issues available, investors do not focus solely on the percentages highlighted in the headlines, but also understand what those numbers actually represent. One thing is certain: there is plenty of choice, and bonds should be on every financial investor’s radar.