Fixed-income Security
Updated: Sep 7, 2021
What is fixed income investing?
Fixed-income security provides a periodic interest payment to an investor for lending money, with the return of the principal amount at its maturity date. Government, Corporations, Municipalities, Agencies issue a debt instrument to finance their operation.
Type of Fixed Income
ETFs Bonds
Government Bond - Treasury Bills-Treasury Bond - Treasury Notes -Treasury Inflation - TIPS
Municipal bonds
Agency bonds
Fannie Mae or Freddie Mac
Certificate of Deposit
High Yield Bond
Callable Bond
Corporate Bond
Preferred Stocks
Benefits Of Fixed Income
Lower Market Risk
Fixed-income investing can provide lower market risk with a well-diversified portfolio and asset classification. Every often, there is a negative correlation between the bond yield and the stock market. In other words, the bond yield falls when the stock market rises.
Capital Preservation
Fixed-income investing is less risky than equity income. It is suitable for an investor who wants to preserve his capital for a lower rate of return. For example, someone planning for his retirement; or people who received a large inheritance can profit from fixed-income investing.
Steady Source of Income
Fixed-income security offers a predictable source of income. A coupon amount can be paid to an investor quarterly, semi-annually, or annually. Therefore, an investor can make predictable financial plans knowing his exact stream of income.
Total Return
The total return is the sum of the rate of return of the investment over time, capital appreciation, dividends, and all other distributions.
Risk of Fixed Income Investing
There is no risk-free investment in the world, even in fixed-income securities. However, one can obtain lower risk associated with fixed-income securities when a portfolio is diversified across industries and indexes. Nonetheless, it is essential to know the four-risks:
Interest Rate Risk
Interest rate risk is defined by the fluctuation of the interest rate of the bond. The interest rate and the bond value are inversely correlated. In fact, the market is not predictable. This is the reason there is a fluctuation of interest rates over time.
To put it another way, the value of the bond falls when the interest rate rises. And when the bond rises, the interest rate falls. The interest rate risk or market risk increases the longer an investor holds a bond.
Inflation Risk
Inflation risk is when the yield on a bond does not keep up with the inflation rate or purchasing power over time. For example, an investor receives a 3 percent coupon payment for five years to satisfy certain expenses. In the second year, he experiences an inflation rate of 5 percent while he is still receiving a 3 percent coupon payment. Under this circumstance, the purchasing power of the bond will decline because of an inflation rate of 5 percent. For appropriate solutions, treasury Inflation – TIPS is the only bond that protects investors again certain inflation risks.
Credit Risk
Credit risk focuses on the risk of the issuers defaulting in the repayment of the principal amount and interest rate on time. In other words, an issuer can uphold the promise to repay the principal amount and/or interest rate at the agreed date.
The most secured bond is a government bond. However, it offers a lower yield. The 10 rating agencies provide a rate to issuers from AAA to D or nothing. A higher Yield bond means a lower credit grade. The credit risk measures the respect of the repayment agreement of the loan by the issuers on time.
Liquidity Risk
An investor should be aware of the liquidity of the fixed-income security before any purchase. Many investors target treasury bonds and certain ETF bonds because of the liquidity of the market. An investor should always check the frequency of trade on the given bond to avoid liquidity risk.