The instruments of the fixed-income securities market are among the most significant in the world financial systems since it provides demand with stable transactions returns. Debt securities which offer interest payments and pay the principal amount upon the face value at a later date upon its maturity. This paper aims at providing information on the classification, characteristics and benefits of Fixed-income securities, its drawbacks and threats and also some examples of such securities.
WHAT ARE FIXED INCOME SECURITIES?
Debt securities are financial assets on which some form of a fixed interest or dividend is paid to the holder for a stated period. These securities are normally used by governments, companies and other organizations in order to finance their activities. Holders are paid amount in the form of interest at periodic interval known as coupons until the security reaches its maturity at which time the face value is paid.
CLASSIFICATION OF FIXED INCOME SECURITIES
Fixed-income securities come in various forms, each with unique characteristics:
1. Government Bonds
- Description: It is a money instrument that is, created by national governments for the purpose of financing expenditures. These include US treasury bonds, bonds of the United Kingdom and Indian government securities.
- Features: They are deemed to be low risk since they are supported by the government.
2. Corporate Bonds
- Description: Troubled by companies for organizational activities, expansions as well as for special projects.
- Features: Have a higher rate with more credit risk issues as compared to government bonds.
3. Municipal Bonds
- Description: Created by state or local governments to fund projects most of which are used in the construction of schools, roads or hospitals among others.
- Features: Quite frequent offer tax benefits, for instance, tax-free interest revenue streams.
4. Of the financial instruments there are Mortgage-Backed Securities (MBS)
- Description: Fixed income obligations backed by a group of home loans.
- Features: The revenue is obtained from the operations of acquiring mortgage payment.
5. Zero-Coupon Bonds
- Description: Sold to the public below par value and do not pay any fixed amount of interest at regular intervals.
- Features: It is the full-face value that goes to the side of investors on the maturity of stocks.
6. Bonds ETFs and Mutual Funds
- Description: Collective investment scheme that aspire to pool funds for the purpose of buying a range of fixed income instruments.
- Features: Services that should be offered include diversification and professional management.
FEATURES OF FIXED INCOME SECURITIES
- Regular Income: Interest payments are made on a fixed intervals and thus the fixed income makes predictions easier.
- Fixed Maturity Date: Interest is paid only at a specific time which is at the time when the principal is repaid.
- Par Value: Par value and can be $1,000 or its equivalent in other currency based on which it is issued.
- Coupon Rate: The credit rate which bears the interest on the invested amount and is usually measured by the stated or PAR value.
- Liquidity: Most of the fixed income securities, including government bonds are easily marketable and have a high level of marketability.
- Credit Rating: Explains the ability of an issuer of the instrument to pay to investors and their ability to pay the amounts in due time.
ADVANTANGES OF FIXED INCOME SECURITUES
- Predictable Income: These securities pay income in form of interest periodically hence perfectly suitable for income investor.
- Capital Preservation: Semi-strong form efficient securities for instance; fixed income securities such as government bonds protect the principal amount.
- Portfolio Diversification: This is good because low correlation with the equities reduce overall portfolio risk.
- Lower Volatility: In general, fixed-income securities fluctuation is comparatively less than the stocks.
- Tax Benefits: Some bonds, for instance municipal bonds come with tax benefits.
DISADVANTAGES OF FIXED INCOME SECURITIES
- Lower Returns: Fixer income security usually offer relatively lower long-term returns than the equities.
- Inflation Risk: The rate of returns they get from fixed interest have the bad aspect of eroding with their purchasing power in inflationary times.
- Interest Rate Risk: Interest rates on bonds vary in reverse to the yields, hence if interest rates rise bond prices drop in a way that can lead to losses.
- Credit Risk: There are times where the issuer may fail to deliver payment especially when it comes to corporate bonds or any fixed income.
- Reinvestment Risk: Coupons may require reinvestment, because of, a lower coupon rates if interest rates dumped.
RISKS ASSOCIATED WITH FIXED INCOME SECURITIES
1. Interest Rate Risk
- The issuer of the bond may fail to repay the borrowed amount plus the interest in full, or, in cases when the interest rates go up, bond prices go down and if an investor has to sell the bond before it matures, he/she will incur losses.
2. Credit Risk
- The possibility that an issuer is unable to make the required interest or principal payments to bondholders.
3. Inflation Risk
- It means that fixed interest payments may reduce their value in real terms during inflation and deflation period.
4. Liquidity Risk
- From the issue of the above, it is clear that some of the bonds particularly those of low quality or from small organizations are not very easy to exchange.
5. Call Risk
- Some bonds can be (called) by the issuer before it gets to the times of maturity and the process is normally disadvantageous to the investor.
EXAMPLES OF FIXED INCOME SECURITIES
Example 1: U.S. Treasury Bonds
- Issuer: U.S. government
- Features: Very high quality, low credit risk, interest rate attached to the bond.
- Use Case: Best for investors for whose priority is the preservation of capital without a much emphasis on the level of returns.
Example 2: Corporate Bond (Apple Inc.)
- Issuer: Apple Inc.
- Features: This provides higher returns to the risks involved as compared to government bonds.
- Use Case: It is recommended for investors who are in search of high yield investment that is minimal risk.
Example 3: Municipal Bond
- Issuer: Local government
- Features: Tax-exempt interest income.
- Use Case: This is more attractive to high income earners hence the most appropriate for those in the high tax bracket.
Example 4: These include; Mortgage-Backed Securities (MBS)
- Issuer: Financial institutions
- Features: Repository of mortgage payments, money collected through loan.
- Use Case: Specifically attractive for investors interested in obtaining yields linked to real estate markets.
CONCLUSION
Debt securities are necessary to build the investment portfolios of anyone who desires to minimize the risks in the financial market. Their income streams are safe and annual, they exhibit less risk compared to other investment products, the risks are diversified, making them the best investment bet for any prudent investor.
However, they have some drawbacks like: the interest risk; the credit risk and inflation risk which are always potential in an investment decision. This logical division will help investors decide on fixed-income securities based on the classification of the types, their characteristics, strengths, and weaknesses.
FAQs
- Is the holding of fixed-income security a wise practice?
However, based on the various objectives as well as risks tolerance, fixed–income securities can actually be a good investment. They offer:
- Stability: Yeats: Fixed income, less risk than equity instruments.
- Diversification: This remains an essential aspect of risk management because it helps minimize the diversifiable risk in a client’s portfolio.
- Capital Preservation: Helps to avoid a direct contact with principal for those investors who value their money.
But the returns generated may be lower than direct investment in equities; they are consequently exposed to risks such as inflation effect and interest rate fluctuation risk.
- What does a fixed-income security classify into?
- Government Bonds: What are often known as ‘Blue-chip’ investments which are fairly secured with the backing of government.
- What is the implication of fixed-income securities?
- There is no absolute safety when it comes to business investments. Fixed-income securities face:
- Default Risk: The possibility of the issuer not being able to pay either the interest or the principal.
- Interest Rate Risk: Value is inversely related to interest rates, therefore, Value declines when interest rates surface.
- Inflation Risk: Free riders may not compensate for lost sales.
- Why fixed income securities are important in India?
Investing in fixed-income securities in India is beneficial because:
- Stable Returns: Offers assured regular income for the individual willing to avoid risks.
- Tax Benefits: While some government bonds and municipal bonds are tax exempted.
- Economic Growth: In a growing economy a bond provides a more stable source of returns than equity.
- Which are the different types of fixed income securities that exist in the Indian market?
Government Securities (G-Secs):
Actually, it is the safest of all these four options for long-term investment.
State Development Loans (SDLs): Issued by Indian states.
Corporate Bonds and Debentures: While investing in these plans, may prove worthwhile in the long run by offering a higher return compared to conventional plans, they are markedly riskier.
Public Provident Fund (PPF): Long-term, tax-free returns.National Savings Certificates (NSC): A guaranteed inflow of cash with tax advantages also.Bank and Post Office FDs: Available to the public at different term lengths.