Fixed Income Securities
Fixed income investments are nothing but loans given by an investor to an issuer. Over here an issuer can be a corporate or government borrower. The borrower promises to pay the investor a fixed amount of interest i.e. coupon on a regular basis until the predetermined maturity date. At maturity, the issuer repays the investor the principal amount of each bond at the face or par value. Fixed-income investment is commonly known as bonds and money market securities.
Features of fixed income
- Maturity – This is the amount that the issuer pays to the bondholder on maturity. It is also known as face value, par value, maturity amount, etc
- Coupon – It is the regular periodic payment that an issuer makes to the investor. It can be calculated as the coupon rate multiplied by the periodic payment. The coupon rate is decided mainly on 2 factors the maturity of the bond and the creditworthiness of the issuer. The coupon is inversely related to the issuer’s creditworthiness. A High credit quality enjoys a lower interest rate and vice versa.
- Principal – It is the face value of the bond which an investor lends to the issuer
- Yield – Yield means a return on the amount invested. The coupon is different from yield. For example, when a bond is traded in the secondary market, the investor pays an amount which is different from the face value so his return can be calculated a coupon divided by amount invested this is yield
The different types of fixed income securities
- Treasury Bills – they are short term money market instrument issued by the government. They are issued at the discount rate and repaid at the face value. there are T bills with a maturity of 91 days, 182 days, 364 days. T-bills are available for a minimum amount of Rs 25,000 and in multiples thereof
- G –Securities – They are long term bonds with a maturity ranging to a period up to 30 years. There are different types of G securities. They are
- Fixed-rate bonds – These security holders are paid a fixed interest rate at fixed intervals.
- Floating rate bonds – These security holders are paid variable interest t fixed intervals.
- Special Securities – These are untradeable securities issued to only specific government projects.
- Certificate of deposit – It is an unsecured, negotiable, short-term instrument issued by commercial banks and the development of financial institutions.CD is issued by banks during periods of tight liquidity, at relatively high-interest rates. The minimum amount of CD should be Rs 1lakh i.e. the minimum deposit that could be accepted from a single subscriber should not be less than Rs 1lakh and in the multiple of Rs 1lakh thereafter. The Maturity period of CD is 7day to 1year.CD can be issued by at a discount on face value. The issuing bank is free to determine the discount /coupon rate. It is freely transferable
- Commercial papers – Commercial paper is an unsecured short-term promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. In order to meet their working capital requirements Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. CP can be issued in denominations of Rs.5 lakes or multiples thereof.
- Bonds – A bond is a loan that investors make to the issuer of the bonds. There are various types of bond like a zero-coupon bond, convertible bond, puttable bond, callable bond, etc.
Let’s look at the market participant in the fixed income market. This table tells us about who the issuers of various securities are and who invest in those securities
SEBI and RBI are the regulators of the fixed income market
Yield and price relationship
Yield and price relationship have an inverse relationship. For example when the rates rise prices fall and vice versa. This is because bonds that are already issued and being traded in the secondary market continuously adjust their prices and yields to be in line with the current interest rate.
Why should an investor invest in the bond market?
It’s a saying that “Don’t put your egg in one basket”. Looking at this we can say that the investor should not invest in just one asset class but should invest in the different asset class in order to have a balanced portfolio. One should invest in the bond market due to the following reasons:-
- Diversification – Bonds being less volatile as compared to equity helps to maintain a diversified portfolio.
- Income generation – Most bonds pay interest on a regular interval and during maturity repays the face value leading to income generation
- Protection of principal – It is very necessary and people need their principal amount back at the time they need money
- Tax benefits – Certain bonds enjoy tax benefits, for example, municipal bonds
- Early repayment – Some bonds can be repaid before the maturity period
|Central Government||Dated Securities||2-30years||RBI, Banks, Insurance Companies, Provident Funds, Mutual Funds, PDs, Individuals|
|State Government||Dated Securities||5-13 years||Banks, Insurance Companies, Provident Funds, RBI, Mutual Funds, Individuals, PDs.|
|PSUs||Bonds, Structured Obligations||5-10 years||Banks, Insurance Companies, Corporate Provident Funds, Mutual Funds, Individuals|
|Corporates||Debentures||1-12 years||Banks, Mutual Funds, Corporates, Individuals|
|Corporates, PDs||Commercial paper||7 days to 1year||Banks, Corporate, Financial institutions, Mutual Funds, Individuals, FIIs|
|Scheduled Commercial Banks||Certificates of Deposit||7 days to 1 year||Banks, Corporations, Individuals, Companies, Trusts, Funds, Associations, FIs, NRIs|
|Bank Bonds||1-10 years||Corporations, Individual Companies, Trusts, Funds, Associations, FIs, NRIs|
|Financial Institutions||CD||1 year to 3 years||Banks, Corporations, Individuals, Companies, Trusts, Funds, Associations, FIs, NRIs|
|Municipal Corporation||Municipal Bonds||0-7 years||Banks, Corporations, Individuals, Companies, Trusts, Funds, Associations, FIs, NRI|
There are the different risk that is involved with the fixed income security. They are
- Inflation risk – Investor faces this risk when there is a fall in the value of the inflows that he receives when he holds a debt instrument
- Interest rate risk – This risk arises as to the interest rate changes which causes a change in the bond prices to rise or fall
- Reinvestment risk – This risk arises when the yields fall as in this situation the investor will have to invest their interest and principal at low rates
- Default risk – There is a risk that the issuer will not be able to repay the principal and the interest amount as promised
- Liquidity risk – It is the risk that the investor will have to sell the bond below the indicative price of the bond.
- Exchange rate risk-. For example, if the rupee increases in value relative to the U.S. dollar, returns will be reduced for an Indian investor who owns bonds denominated in dollars.
There are different rating agencies which give a rating to a bond based on certain expectations and assumptions about a variable that impact the issuer’s performance. A credit rating doesn’t represent whether an investor should really buy, sell or hold a debt instrument. It does not give an assurance of the repayment of the debt. A rating is just an opinion on the risk associated with the repayment of debt. In other words, it gives an estimate of the likelihood of the default. Higher the rating lower is the risk of default. Lower the risk of default, lower is the interest expected from the issuer. Rating is provided to any issuer of the bond, for example, an individual, corporate, state, sovereign government.
The careers available in the bond market are as follows: