Investing in bonds: characteristics, valuation and profitability

The bond market is of increasing interest to people who want to invest and build financial assets or diversify their portfolios. After going through a period of low, even negative, rates during the post-COVID inflationary cycle and monetary tightening by central banks, it rose from the ashes in 2022, representing more than $130 trillion. If you are interested in the subject, let us explain what a bond is, how to acquire one, and what level of risk this type of investment involves.

What is a bond?

Before we go any further, what is a bond? It is a financial security issued by various parties with the aim of borrowing money from investors, called bondholders. What does that mean? This could be a company, a public sector entity, or the government. Once you have purchased a bond, you become a creditor of the issuer (the person to whom the issuer of the security owes money, because it has been lent) and generally receive interest paid periodically, also known as a coupon. As for your capital, it is repaid at maturity.

As a security tradable on the stock market, a bond's value changes daily based on trading activity and is traditionally quoted as a percentage of its nominal value, which facilitates comparisons between bonds with different characteristics (maturity, identity of the issuer, etc.).

Fixed-rate bond

A fixed-rate bond has the particularity of having a coupon (interest) fixed in advance in the issue contract. Interest, for its part, is paid annually on the anniversary date specified in the said contract.

💡 Did you know?
A bond can be issued with an issue premium (issue price lower than the nominal value or initial capital) or a redemption premium (redemption price higher than the nominal value).

Floating-rate bond

A floating-rate bond corresponds to a bond whose coupon is indexed to a rate index mentioned in the issuance contract, which varies over a reference period. In this sense, the coupon can be quarterly, semi-annual, or annual. It can also be supplemented by the face margin, which is a complementary remuneration to the index.

Among floating-rate bonds, there are two categories:

• those with adjustable rates: the reference index used to calculate the coupon is set at the beginning of the period and adjusted at each maturity.
• those with variable rates: unlike bonds with adjustable rates, their reference index is not known at the beginning of the reference period. What does this mean? The coupon changes according to an estimate based on the index for the previous period.

Obligation assimilable du Trésor (OAT)

An OAT is a bond issued by the French Republic. It is issued by the Agence France Trésor (AFT) and the department of the supervising ministry. So, how do you own one? You can buy them through monthly auctions (primary market sales). The government makes an announcement a few days beforehand to explain the characteristics of the securities issued and give an indication of the volume that will be issued.

💡 Did you know?
Issuing a convertible bond allows the government to guarantee liquidity in the debt market, which is a key element in attracting investors. This high liquidity makes it easier to buy and resell securities, with reduced spreads between buying and selling prices.

Among the Treasury's comparable bonds, there are 3 categories:

• Fixed-rate bonds: These have the same characteristics as fixed-rate bonds, but the State can top up previously issued bonds so that the nominal rate moves away from the market rate;
• Inflation-indexed bonds: Also known as OATEI (OAT indexed to the eurozone price index), their coupons and capital repayment are based on the level of inflation in the future;
• Striped bonds: These are fixed-rate OATs separated into coupon certificates and principal certificates, which can be traded separately.

Financial bonds sustainable

Also known as a green bond, a green bond is intended for a project with a positive environmental impact. Unlike a so-called classic bond, it specifies what it is financing and its green nature.

💡 Did you know?
The first green bond was issued in the United States, where this market has continued to grow ever since!

Social and sustainable bonds

On the one hand, social bonds aim to finance projects with a social impact, particularly among the most vulnerable populations. Indicators must be measurable and verifiable, like performance targets.

On the other hand, sustainability-linked bonds concern projects that sustainably meet ESG (Environmental, Social, and Governance) criteria.

ESG Criteria

ESG criteria are indicators that “allow an economic player to be evaluated outside of the usual financial criteria of profitability, share price, and growth prospects” (AMF – Autorité des Marchés Financiers).

• The first concerns “Environment”, encompassing everything related to climate change and biodiversity protection.
• The second represents “Social”. It values ​​human capital, health and safety, as well as data confidentiality and security.
• The final axis, that of “Governance”, relates to the company’s structure, its behavior, its management, and potential instabilities.

How is a bond valued?

To help you understand what a bond earns you, let us give you some guidance. The valuation of a bond is based on calculating the present value of the future cash flows it generates – namely coupon payments and the repayment of capital at maturity. The calculation is done by discounting these cash flows using the discount rate.

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