Analysis of interest income (2024)

Fixed income analysis is the process of evaluating and analyzing fixed income securities for investment purposes.

Fixed income securities represent a separate investment category. Investors and analysts conduct interest rate analyzes for

• Evaluate the risk characteristics underlying debt securities and assess the borrowing entity's ability to meet its financial obligations (credit analysis)
• Identify which debt securities offer attractive investment opportunities
• Determine the appropriate valuation (or value) of debt securities in the market
• Compare the investment characteristics (e.g. risk and return) of debt securities with each other and with other asset classes such as equities, derivatives, real estate and others.

Features and characteristics of fixed income securities

Some important features of fixed income securities include:

• Government bonds versus corporate bonds
  • At a very broad level, fixed income securities can be categorized as:
    • Government
      • E.g. US government bonds
  • Commercial
    • Bonds issued by public companies
    • Publisher
      • The party, entity, or company that sells the debt obligation to investors
      • This is the borrowing entity
      • Borrower or bondholder
        • The party who purchased the debt obligation (i.e., the lender)
        • Principal or face value
          • The amount borrowed, which must be repaid in full at a later date
          • Interest
            • The interest rate that applies to the principal amount borrowed
            • Periodic payments
              • The periodic dates over the life of the debt when the borrower is responsible for making regular payments of interest or principal (or both)
              • Maturity
                • The length of time from the inception of the debt to its termination
                • Fixed income options
                  • Options embedded in fixed income securities that give the lender or borrower the right to settle the obligation
                    • Callable bond – the issuer of the debt obligation retains the right to call the bond before maturity
                    • Putable Bond – the holder of the debt obligation (the borrower) retains the right to redeem the bond before maturity
                    • Convertibility
                      • Convertible bonds allow the bondholder to convert the debt obligation into common stock

                      Elements of fixed income analysis

                      See Also

                      Interest Rate Outlook 2024: Bonds Come Roaring Back

                      The following elements are typically common when analyzing a company's fixed income assets

                      • Credit analysis
                        • Analysis of the company's accounts
                        • Assessment of creditworthiness and ability to pay
                        • Analysis of collateral and covenants
                        • Risk analysis
                          • Fixed income companies are exposed to certain risks, including one or more of the following risks
                            • Interest risk
                            • Inflation risk
                            • Credit or default risk
                            • Liquidity risk
                            • Currency risk
                            • Highest risk
                            • Fixed income assessment
                              • A time value-based formula and method is used to value fixed income securities
                              • The interest payments and principal amount of the bond are calculated back to today to arrive at a present value (the value of the bond).
                                • The present value of each future cash flow is found and added
                      • The following items are required to carry out the valuation
                        • The coupon or interest
                        • The coupon or interest payments
                        • Face value or principal amount
                        • The discount rate used to determine the present value of any future cash flow
                        • Comparison with government bonds
                          • The interest income analysis also includes a comparison of corporate bond yields or returns with risk-free U.S. government bonds (Treasuries)
                            • These are very safe, liquid and debt obligations
                            • The return on government bonds is seen by investors as the minimum acceptable or possible return in the market
                            • The return on fixed rate corporate bonds is compared to the return on US government bonds to measure the 'extra' return on offer (also known as the risk premium)
                              • This additional return is required by investors to accept the risks associated with fixed income corporate securities (see above for a list of risks)

                      Conclusion

                      Fixed income analysis is the analytical framework used to evaluate and value fixed income securities for investment purposes. This includes credit and risk analyzes and bond valuation. It applies to securities such as government and corporate bonds and plays an important role in the trading and pricing of such instruments in the market.

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