Understanding stock market bonds
The stock market vocabulary is not always crystal clear. Most investors are familiar with the stock market, but it can be more difficult to get a clear picture of another buying option: bonds. Learn more about it here!
What is a bond?
When you buy a bond, you are lending money in exchange for a fee that is known at the outset. Governments, corporations and municipalities issue bonds when they need capital. Like a loan, a bond pays interest regularly and repays the principal at a stated time, known as maturity. A bond can be viewed, like stocks, as a financial investment.
The functioning of bonds
Bonds have the following three main characteristics :
The face value: the face value is the amount borrowed by a security.
The coupon: the coupon is the amount paid by the issuer of the bond to its owner. The payments can be regular or at the end of the maturity.
The maturity date: The maturity date is the date on which the face value must be repaid by the issuer of the bond.
The maturity date of a bond can exceed 20 or 30 years if the issuer is a government, for example, but generally it does not exceed a few years.
The primary and secondary market
The primary market, also known as the issue market, is a place where bonds (or stocks) freshly created by companies seeking funds are offered for sale to investors for the first time without an intermediary.
A bond does not have to be held to maturity. It can be resold to some other investor: this is the secondary market.
The different types of bonds
Government bonds
It is possible to buy bonds issued by a State or by a public entity such as a region, European Investment Bank, etc. It is possible to subscribe to OATs (Obligations Assimilables du Trésor), i.e. government bonds, on a regular basis, even if individuals are very rare on this market. Information on government issues can be found on the Agence France Trésor website. Government bonds from Western countries are considered risk-free. For this reason, their yield is very low, even negative.
Corporate Bonds
It is also possible to buy bonds from a private issuer, i.e. a large international company or a good-sized company capable of going to the financial markets. The vast majority of large companies listed on the stock exchange issue bonds, such as LMVH, Renault, Total, etc.
Advantages and disadvantages
There are several advantages to including bonds in your stock portfolio.
Reducing the volatility of your portfolio. Bonds are much less volatile than stocks. This is because the income from a bond (the coupon) is known in advance, whereas the income from a stock (the dividend) is uncertain.
Diversification: Often when stock prices fall, bonds rise. This way, your portfolio will be better able to weather market crashes.
There are several ways to invest in bonds. It is possible to invest directly, but also through mutual funds or ETFs.
Nevertheless, bonds also come with disadvantages.
Performance: the performance of bonds is lower than that of stocks.
Interest rate risk: Interest rate risk is related to the change in market interest rates after a bond is issued. If the market rate becomes higher than the rate on the bond you bought, it will devalue your bond. This risk is also related to the life of a bond. The longer the life of a bond, the more fluctuations in the market rate will occur and the greater the risk of the bond falling.
Bonds are often included in diversified investment strategies, such as Market-Signals’ ETF portfolios, to limit risk.
