Innovation and Financial Markets

7Innovation and Credit Risk

For investors, the two main asset classes are equities and bonds. Equity markets were discussed in Chapter 6 and markets appeared to value, globally, innovation. This means that the stock prices of the most innovative companies, which manage to convert this into profit, tend to rise. We will now discuss the link between innovation and bond markets and, more specifically, credit risk.

7.1. Credit risk

In the bond markets, investors face two main risks: interest rate risk and credit risk.

Interest rate risk corresponds to the sensitivity of a bond to a rise (or fall) in interest rates. The idea is that if the general level of interest rates rises, this will result in a fall in bond prices. To understand this relationship, it is necessary to look at the general characteristics of bonds. The latter (in their classic formula, called plain vanilla) are defined by the following general characteristics:

• – a final maturity: unlike equities whose “final maturity” is uncertain, at best infinite, bonds are defined by a final maturity. This is why we speak of investment with a fixed maturity;
• – a fixed coupon rate: the coupon rate is the yield that will be paid each year to the investor by the issuer of the bond. The currency amount is calculated as a percentage of the nominal amount invested.

There are also some special features that are important for a good understanding of the product:

• – the price of a bond is determined as a percentage of the nominal ...