Fixed income (2024)

What is fixed income?

Fixed income securities broadly refer to those types of investment securities that pay investors fixed interest or dividend payments until theirmaturitydate. At maturity, investors are repaid the capital they invested. Government and corporate bonds are the most common types of fixed income products.

Unlike sharesthat may not pay cash flows to investors or variable income securities where payments may change based on an underlying measure (such as short-term interest rates). The payments on a fixed-income security are known in advance and remain fixed throughout the period.

In addition to the direct purchase of fixed-income securities, there are several fixed-income securitiesexchange traded funds(ETFs) and mutual funds available to investors.

Understanding fixed income

Companies and governments issue debt securities to raise money to finance day-to-day operations and finance major projects. For investors, fixed income instruments pay a fixed return in exchange for lending their money. At maturity, investors are repaid the original amount they invested, the so-called principal amount.

For example, a company might issue a 5% bond with a value of $1,000face value or face valuewhich matures in five years. The investor buys the bond for $1,000 and is not repaid until the end of the five years. During the five years the company pays interest:called coupon payments— based on a rate of 5% per year. As a result, the investor receives $50 per year for five years. At the end of the five years, the investor will receive the originally invested € 1,000 back at the maturity date. Investors can also find fixed income investments that pay coupon payments monthly, quarterly or semi-annually.

Fixed income securities are recommended for conservative investors looking for a diversified portfolio. The percentage of the portfolio devoted to fixed income depends on the investor's investment style. There is also the option to diversify the portfolio with a mix of fixed income products and equities, creating a portfolio that can consist of 50% fixed income products and 50% equities.

Government bonds and notes, municipal bonds, corporate bonds and certificates of deposit (CDs) are all examples of fixed income products. Bonds are traded over-the-counter (OTC).the bond marketand secondary market.

Types of fixed income products

As mentioned earlier, the most common example of a fixed income asset is a government or corporate bond. The most common government bonds are issued by the US government and are commonly referred to as government bonds. Fixed income securities are also offered by non-US governments and corporations.

These are the most common types of fixed income products:

• Treasury bills (Treasury bills)are short-term fixed-income securities with a term of one year and that do not yield a coupon return. Investors purchase the note at a price lower than the face value, and investors earn that difference at maturity.
• Treasury bills (T-nut)have terms between two and ten years, pay a fixed interest rate and are sold in multiples of $100. At the end of the term, investors are repaid the principal but receive semi-annual interest payments until maturity.
• government bonds (T-binder)vergelijkbaar met de T-bill, behalve dat deze over 20 of 30 jaar rijpt. Staatsobligaties kunnen worden gekocht in veelvouden van $ 100.
• Inflation-protected government bonds (TIPS)protect investors against inflation. The principal amount of a TIPS bond is adjusted for inflation and deflation.
• INmunicipal bondsimilar to a treasury bill in that it is issued by the state, except it is issued and backed by a state, municipality, or county instead of the federal government, and is used to raise capital to finance local expenditures. Muni bonds can also provide tax-free benefits for investors.
• Corporate bondsare available in different types, and the price and interest offered largely depend on the financial stability and creditworthiness of the company. Bonds with a higher credit rating generally pay a lower coupon rate.
• Junk Bonds– also called high-yield bonds – are corporate issues that pay a higher coupon due to the higher risk of default. Default occurs when a company fails to repay the principal and interest on a bond or debt security.
• INdepositumsbevis (CD)is a fixed income instrument offered by financial institutions with a term of less than five years. The rate is higher than a typical savings account, and CDs have FDIC or National Credit Union Administration (NCUA) protection.
  

How to invest in fixed income securities

Investors looking to add fixed income securities to their portfolios have several options. Today, most brokers offer clients direct access to a variety of bond markets, from government bonds to corporate bonds and munis. For those who do not want to opt for individual bonds, there are fixed income investment funds (bond funds) provide exposure to various bonds and debt instruments. These funds allow the investor to generate an income stream through the professional management of the portfolio.Fixed Income ETFsworks much like a mutual fund, but can be more accessible and cost-effective for individual investors. These ETFs can focus on specific credit ratings, durations or other factors. ETFs also carry a professional management fee.

Fixed income investing is generally a conservative strategy that generates returns from low-risk securities that pay a predictable interest rate. Because the risk is lower, the interest coupon payments are usually lower as well. Building an interest portfolio can consist of investing in bonds,bond fundsand certificates of deposit (CDs). Such a strategy using interest rate products is calledis increasingstrategy.

A ladder strategy provides stable interest income through the investment in a number of short-term bonds. As bonds mature, the portfolio manager reinvests the principal amount repaid in new short-term bonds that extend the ladder. This method gives the investor access to immediate capital and avoids the loss of rising market interest rates.

For example, an investment of €60,000 can be divided into bonds with a term of one, two and three years. The investor divides the principal amount of $60,000 into three equal parts and invests $20,000 in each of the three bonds. When the one-year bond matures, the $20,000 principal is converted into a bond that matures one year after the original three-year bond. When the second bond matures, these funds are converted into a bond that extends the ladder for another year. In this way, the investor has a stable return on interest income and can benefit from any higher interest rates.

Benefits of fixed income

Generate income

Fixed income investments provide investors with a steady stream of income over the life of the bond or debt instrument, while providing the issuer with much-needed access to capital or cash. A stable income allows investors to plan their consumption, one of the reasons for thispopular products in retirement portfolios.

Relatively less volatile

The interest payments from fixed income products can also help investors stabilize the risk return in their investment portfoliomarket risk. Voor beleggers die aandelen aanhouden, kunnen de prijzen fluctueren, wat kan resulteren in grote winsten of verliezen. De stabiele en stabiele rentebetalingen uit vastrentende producten kunnen verliezen als gevolg van de daling van de aandelenkoersen gedeeltelijk compenseren. Als gevolg hiervan helpen deze veilige beleggingen het risico van een beleggingsportefeuille te diversifiëren.

Guarantees

Fixed income investments in the form of government bonds (T-bonds) are also backed by the US government.

Although corporate bonds are not insured, they are backed by the financial viability of the underlying company. If a company goes into bankruptcy or liquidation, bondholders have a higher claim on the company's assets than ordinary shareholders.In addition, bond investments at listed companies are supported bySecurities Investor Protection Corporation(SIPC) up to $500,000 in coverage for cash and securities held by the company. Fixed income CDs have Federal Deposit Insurance Corporation (FDIC) protection up to $250,000 each

Risks associated with fixed income securities

While there are many benefits to fixed income products, as with all investments, there are also several risks that investors should be aware of before purchasing.

Credit and default risk

As previously mentioned, government bonds and CDs enjoy protection through the government and the FDIC.Corporate debt, while less secure, is still more eligible for repayment than that of shareholders. When choosing an investment, pay attention to creditrating of the bondand the underlying company. Bonds with a rating lower than BBB are of low quality and are considered junk bonds.

The credit risk associated with a company can have a varying effect on the valuation of the interest rate instrument until its maturity. If a company is struggling, the prices of its bonds on the secondary market may fall in value. If an investor tries to sell a bond of a troubled company, the bond may sell for less than par or face value. It may also become difficult for investors to sell the bond on the open market at a reasonable price, or at all, because there is no demand for it.

Bond prices can rise and fall over the life of the bond. If the investor holds the bond until maturity, the price movements are immaterial as the investor will be paid the face value of the bond at maturity. However, if the bondholder sells the bond through a broker or financial institution before maturity, the investor will receive the current market price at the time of sale. The sales price may result in a gain or loss on the investment depending on the underlying company, the coupon rate and current market interest rates.

Interest risk

Investors in fixed income securities may encounter thisinterest risk. This risk occurs in an environment in which market interest rates rise and the interest paid by the bond lags behind. In this case, the bond would lose value on the secondary bond market. The investor's capital is also tied up in the investment and he or she cannot start earning a higher income without incurring an initial loss.

For example, if an investor bought a 2-year bond that paid 2.5% per year, and the interest rate on 2-year bonds rose to 5%, then the investor is stuck with 2.5%. For better or worse, investors who hold fixed-income products receive their fixed interest rate, regardless of where interest rates move in the market.

Inflation risks

Inflation risk is also a danger for investors in fixed income securities. The speed at which prices rise in the economy is mentionedinflation. When prices rise or inflation increases, the profits from fixed income securities are eaten away. For example, if you Fixed rate debt instruments yield a return of 2% and inflation rises by 1.5%. The investor loses and earns only a return of 0.5% in real terms.

Interest Income Analysis: What to Consider

When deciding which of these financial products to invest in, investors conduct interest rate analyses. The techniques below are used to assess which investments make the most sense for the investor's risk appetite and expected return.

Interest rate analysis often starts with risk. All investments have a risk-return relationship; All things being equal, the return on an investment should be higher when the investment is riskier. Therefore, fixed income analysis assesses not only whether an investor is comfortable with the level of risk he or she is taking, but also whether the level of risk is appropriate for the return of a fixed income security.

With fixed-income securities, the risk is linked to the creditworthiness of the issuing company, the term of the fixed-income security and the sector in which the company operates. For example, you will often find the lowest returns on fixed income securities related to the ONS. government. Because the risk of default is low, US bonds are often seen as safer forms of investment. On the other hand, companies (especially those with cash flow problems) can pose a greater risk.

Some fixed income securities offer periodic payments. This allows investors to get money back over the life of the investment. This also reduces risk because not all of the capital has to be repaid at the end of a potentially long bond period.

Finally, different fixed income securities have different characteristics that make them more or less attractive. Some are convertible, allowing the debtor to repay the entire bond before maturity. Other offers the option to convert the interest security into ordinary shares. It is important to consider which characteristics are important to you, as any favorable period is likely to reduce yield.

Example of fixed income

To illustrate, let's say PepsiCo (FUT) issues fixed-rate bonds for a new bottling plant in Argentina. The issued 5% bond is available atnominal valueof $1,000 each and payable in five years. The company plans to use proceeds from the new facility to pay down debt.

You buy ten bonds that cost a total of $10,000 and receive $500 in interest payments each year for five years (0.05 x $10,000 = $500). The interest amount is fixed and provides you with a fixed income. The company receives $10,000 and uses the money to build the overseas factory. At maturity in five years, the company repays the $10,000 principal to the investor, who has earned a total of $2,500 in interest over the five years ($500 x five years).

In short

Fixed income securities refer to debt investments that pay a fixed interest rate along with the return on the principal amount borrowed at maturity. This includes different types of bonds and certificates of deposit. Fixed income as an asset class is generally less volatile than equities and is considered more conservative. A well-diversified portfolio should have some allocation to bonds that increase as the time horizon shortens (for example, as retirement age approaches).