Bond

What is a bond?

A bond is a debt security issued by companies, states, and public sector entities to borrow on the bond market. Buying a bond with a value of €100, issued by a company, is equivalent to lending it €100. Bonds are remunerated by an interest rate called a "coupon," paid periodically and calculated based on the nominal value of the security. Bonds are redeemable at the agreed maturity date.

Bond issuers

Bonds issued by companies

A corporate bond is a debt security issued by a company and offered for sale to investors. The quality of the bond is generally linked to the company's ability to repay, which depends on its future income prospects. In some cases, the company's physical assets can be used as collateral (assets serving as security) for the bonds.  

Corporate bonds are considered riskier than government loans, and consequently their interest rates are almost always higher, even for companies with the highest credit quality.

Bonds issued by the State

A government bond is a debt security issued by a government to support public expenditures and most often denominated in the country's national currency, offered for sale to investors. Public debt is fully guaranteed by the government.

In Europe, government bonds are frequently called "Govies." The U.S. federal government's debt securities include savings bonds, Treasury bills, Treasury Inflation-Protected Securities (TIPS), and other bonds.

Before investing in government bonds, investors must assess several associated risks such as country risk, political risk, inflation risk, and interest rate risk.

Issuer ratings

Issuers receive a financial rating (also called a rating) that measures the financial solvency of the issuer (Company or State). It is expressed through grades assigned by rating agencies such as Moody's, Standard & Poor’s, or Fitch Ratings.  

Bonds issued by an issuer with a lower rating than another issuer will have a higher rate, but this remuneration is the counterpart of a higher risk.

The main types of bonds

Les obligations à taux fixe

Fixed-rate bonds are the most common type of bonds. The issuer commits to paying a constant income throughout the duration of the loan. The amount of the coupons is known, set in advance at issuance, and does not change during the life of the security. In our previous example, the bond with a value of €100 over a 5-year period at a fixed rate of 3% resulted in an annual coupon of €3.

Floating rate notes

Floating rate bonds are bonds whose issuer commits to paying an income that varies according to market rates (e.g., ESTER or EURIBOR) throughout the duration of the loan.

Convertible bonds

Convertible bonds are bonds that can be exchanged for a predetermined number of shares of the issuer. The price and timing are predetermined.

Zero-coupon bonds

Zero-coupon bonds are bonds that do not pay interest during the life of the security. The interest and the "principal" are repaid at maturity.

Inflation-linked bonds

Inflation-linked bonds are bonds whose interest rate is tied to inflation. This helps protect income from risks related to inflation.

How does the price of a bond change?

The value of a fixed-rate bond fluctuates, both upwards and downwards, inversely to the movement of interest rates, meaning that the price of a bond increases if interest rates fall and vice versa.

At the bond's maturity, the investor recovers their initial capital as well as the final coupon (except in the case of bankruptcy or serious default of the financial institution).

The main risks associated with bonds

The risk of bankruptcy: the risk that the borrower, in the event of bankruptcy, will never repay their loan.

The interest rate risk: the risk that market interest rates will rise above the yield.

The credit risk: in the event of a deterioration in an economic sector, investors demand a higher yield for all bonds in the sector, given that the risk is higher. Thus, the prices of bonds issued by companies in the sector will fall.

The liquidity risk: it represents the degree of difficulty in being able to quickly dispose of one's financial asset at the desired price.

The exchange rate risk: the return on an investment in a foreign currency will depend on the exchange rate of that currency relative to the investor's currency.