What is a Fixed Income?
Fixed Income is a name given to the group of investment products that provide fixed income. In general, they are debt instruments such as bonds, notes and deposits. Fixed income is often issued by governments or other public bodies in order to raise funds with which they can carry out various activities such as investing in infrastructure projects (e.g., building bridges or tunnels) and supporting the economy in times of economic growth or recession. In a similar way as observed by Fintalent’s Fixed Income Consultants, companies can issue fixed income securities to raise funds for certain purposes including funding new investments and repaying existing debts.
The first instrument created for the purpose of providing fixed income was called “consol”. It was issued in 1752 by the British government to help cover the costs of any war that might break out with Spain. Other governments followed Britain’s example and tried issuing their own consol-type securities.
In most instances, consol instruments were created to fund only a specific project that was considered critical for the country in terms of promoting industrialization or improving its economy. However, as European countries became more industrialized, companies and governments started issuing more complex fixed income securities in order to raise larger amounts of money. In addition they began offering different types of fixed income instruments that could be traded on stock exchanges such as Euronext, NYSE and Nasdaq. This, in turn, helped to increase liquidity into the fixed income market, creating a wider and more efficient market for investors to invest.
One of the most popular types of fixed income instruments are those known as “bonds”. These are debt securities that come with an interest rate (also called “coupon”) that can be paid either at regular intervals or at maturity. The time between each coupon payment is known as the “maturity period”. Bonds that pay coupons every six months are known as “half-yearly” bonds and those paying coupons every year are known as “annual” bonds.
Another popular fixed income instrument is the Deposit Receipt (DR). The DR is similar to a bank deposit in that the holder of the DR receives interest on the amount of money invested by the issuer. However, DRS do not have an official maturity period and therefore can be traded throughout their lifetime. Most DRS offer a fixed rate of return and are therefore suited to investors who want long-term financial security and stability.
Fixed income securities are often divided into categories based on the term they offer. For example, “term” bonds, which will mature at any time between one and ten years, are preferred by those investors who need money for short-term borrowing and investment needs within a specific time period (e.g., when planning a vacation). Those who need to invest money for a longer term, and without any specific focus on the duration of their investment, can choose “callable” bonds. These securities have an option given to the issuer (usually the managers of the bond) whereby they may redeem or call back their investments in order to use them for other purposes. Debt securities that are either redeemable at any time or callable at a certain date are known as “contingent” debt securities and those that have a fixed maturity date are known as “fixed” debt securities.
There are also different types of fixed income instruments available for investors with different aims and needs. One of the most important distinctions is the maturity of these securities. The common types of fixed income securities are those that can be paid either at regular intervals or at maturity. The two most popular options include “term” and “callable” fixed income investments. Term fixed income instruments are usually long-term, such as five to seven years, whereas callable fixed income instruments have a defined earlier deadline for redemption or repayment in order to help reduce volatility in a portfolio.
Some bonds are called “zero coupon”. Zeros are considered a discount because they have no interest payments but rather will require periodic payments for their entire duration years (which may be specified as “zero coupon rate”). The most common example of a zero coupon bond is the Eurobond. Issuers usually give a 10-year maturity period.
Issuers may also offer the option of “callable” fixed income securities, which are usually more liquid and easier to sell than other types of fixed income investments. These securities have an option given to them (usually the managers of the bond) whereby they may redeem or call back their investments in order to use them for other purposes.
Fixed income instruments can also be classified by their risk level. The main categories include “safe” and “high risk”. Some examples of safe fixed income securities include US Treasury Bonds, Japanese government bonds, US government agency bonds and Euro Bank notes, among others. These are considered safer investments because they are issued by trustworthy and financially stable governments or government agencies.
As mentioned, fixed income securities can be traded on stock exchanges such as Euronext and NYSE. This is a key characteristic of fixed income securities because it allows investors to quickly sell their investments should they so wish and therefore helps to protect them against any sudden changes in the market. The following are three of the most popular types of fixed income instruments that can be traded on these stock exchanges:
The agency bond , also known as an “agency debt security”, is issued by a government agency that has been authorized to borrow from the government’s budget. These bonds are issued on behalf of a government agency and backed by the agency. Because they are not backed by a certain amount of assets, they have no official maturity period and, therefore, do not offer guaranteed returns.
The corporate bond is issued by companies or corporations that have been granted the authority to borrow money from lenders. They are usually offered for sale in the secondary market after their initial issuance due to investors’ preference for them over government securities. The duration of corporate bonds ranges from one week to ten years, with their maturity date determined when their redemption date arrives. Like government debt securities, these fixed income investments can pay either at regular intervals or at maturity.
Finally, we come to the municipal bonds . These are fixed income securities issued by municipalities or local governments (such as counties and cities) for the purposes of raising capital for projects. A specific date is established when the municipality can redeem or call back its security. Municipal bonds yield higher returns than government agency bonds but are also more risky in that they carry greater risk of default under certain circumstances.
Categories of Fixed income Securities
Fixed income instruments are often categorized according to their maturity period. For example, “term” bonds mature at any time between one and ten years, and are therefore more appropriate for investors who need to borrow money and then invest it for a specific time period (e.g., when planning a vacation). Those who need to invest money for a longer term, and without any specific focus on the duration of their investment, can choose “callable”. These securities have an option given to the issuer (usually the managers of the bond) whereby they may redeem or call back their investments in order to use them for other purposes. Debt securities that are either redeemable at any time or callable at a certain date are known as “contingent” securities.
Fixed income instruments can also be classified according to their risk level. The main categories include “safe” and “high risk”. Some examples of safe fixed income securities include US Treasury Bonds, Japanese government bonds, US government agency bonds and Euro Bank notes, among others. These are considered safer investments because they are issued by trustworthy and financially stable governments or government agencies.
Another categorization is the credit rating of fixed income securities. The most common ratings are “investment grade”, “speculative grade” and “junk”. This latter category includes lower quality fixed income securities that have a high risk of default.
