Fixed Income Investments & Risks Involved:

Fixed Income Investments types, features and risk involved

What are Fixed Income Investments?

Fixed income investments are those that pay investors a fixed rate of interest or dividends until the instrument matures. Since the Fixed Income Instruments do not provide Capital appreciation. Investors are reimbursed for the principal amount invested at maturity. 

For example; Fixed deposits (FDs), Corporate & Government Bonds, Provident Funds, etc.

Fixed income instruments are financial securities that provide guaranteed returns while also protecting the investor’s cash. They are immune to market fluctuations and provide a set rate of interest for the duration of the investment.

If your risk tolerance is moderate or low, you can use a fixed income instrument to grow your financial corpus for various life goals. The following are some of the many fixed income strategies that you might consider investing in and including in your portfolio.

How Does Fixed Income Work?

The word “fixed income” refers to the interest payments received by an investor, which are determined by the borrower’s creditworthiness and current interest rates. In general, the longer the maturity of fixed income products such as bonds, the greater the interest rate, referred to as the coupon.

The borrower is willing to pay a higher interest rate in exchange for the ability to borrow money for an extended period of time. At the end of the term or maturity of the security, the borrower pays back the money they borrowed, which is called the principal or “par value.”

Most Known Fixed Income Securities:

Corporate & Government Bonds

Bonds constitute a whole field of financial or investment research in and of themselves. They can be broadly characterized as loans made by investors to an issuer with the promise of repayment of the principal amount at the specified maturity date, as well as periodic coupon payments (usually every six months) representing interest on the loan. 

The purpose of these loans varies considerably. Typically, bonds are issued by governments or companies seeking to finance projects or operations.

Money Market Instruments

Commercial paper, banker’s acceptances, certificates of deposit (CD), and repurchase agreements (“repo”) are all examples of money market products. Treasury bills are legally included in this category, but owing to the huge amount of trading they see, they have a life of their own.

Treasury Bills

Treasury bills, often regarded as the safest short-term financial instrument, are issued by the US federal government. These securities often have maturities of 28, 91, or 182 days (one month, three months, or six months). These instruments do not have a fixed coupon or interest rate.

Rather than that, they are sold at a discount to their face value, the difference between which is the interest rate they give investors. As a basic example, if a Treasury note with a face value of Rs.100, or par value, sells for Rs.90, it offers about 10% interest.

Asset Securities Backed (ABS)

Asset-backed Securities (ABS) are debt instruments backed by “securitized” financial assets such as credit card receivables, auto loans, or home equity loans. 

An ABS is a collection of such assets bundled into a single fixed-income instrument. Asset-backed securities are frequently preferred by investors over corporate debt.

fixed income investments types and features

Features of Fixed Income Investments:

  1. They offer low-risk, low-return type investments.
  2. Insurance for difficult times. They provide safety as you can take a loan against these instruments during Unfortunate times. 
  3. A passive source for a regular stream of income. 
  4. Tax Benefits.
  5. Flexible tenures with optimum options for liquidity.

Why Fixed Income Instruments are favored amongst Indians?

Most Indians especially those born before the 1980s do not view the Stock Market as the Millennials do. Millennials prefer to take risks and be more adventurous. Hence, nowadays we see many India’s coming into the Stock Market, some even going into other much risky assets such as Crypto. But, the non-millennials prefer Safety over Better returns.

Thus, until now, most Indians park their savings under various Fixed Income Investments. 

But, these Fixed income instruments aren’t safe in ways that truly matter. I mean, in the eyes of Inflating money circulation, and the aftermath depreciation of purchasing power. The Fixed Income instruments lack to entice the new generational investors.

Risks involved in Fixed Income Instruments:

The primary risk associated with fixed-income securities is that the borrower will default on its obligation. Such risks are reflected in the interest or coupon rate offered by the asset, with securities having a higher risk of default providing investors with higher interest rates.

Additional hazards include exchange rate risk for assets denominated in a currency other than the US dollar (for example, foreign government bonds) and interest rate risk, which is the risk that interest rate fluctuations would affect the market value of a fixed-income security an investor owns.

For instance, if an investor owns a 10-year bond paying 3% interest and interest rates rise and new 10-year bonds are released paying 4% interest, the investor’s bond paying 3% interest becomes less valuable.

Coupon Rate Unchanged 

Fixed income instruments as the name suggests, are Instruments providing fixed rates of income to the investors. This becomes a hassle when the interest rates rise and you are locked in your investment with lower rates. 

For example, right now FD offers 6 to 6.5%, if you subscribe to FD now and in the coming 2 years as the interest rates rise, you are at a disadvantage for you are holding an instrument with reduced rates.  

Liquidity Issues

Although Fixed Instruments provide optimum liquidity, they are not the most feasible option when at need. Because pulling out funds from these investments as and when needed can attract penalties. We call it the Premature withdrawal penalty.

Inflation Worries 

This is probably the most important risk. The one that’s not vividly known amongst investors. Imagine owning a Fixed Income instrument that gives a 6% return on investment and no capital appreciation. 

With inflation averaging at 4 to 6% each year, your investment on the net affects yields hardly 1 to 2% in this case.

What Should Investors Do?

Owing Fixed Income Instruments is suggested. But the same needs to be done due diligently. Invest in these assets not more than 15 to 20% of your portfolio or as per your financial condition & risk-averse behavior. 

A conservative investor can own safe assets while risky investors can choose to limit owning Fixed income instruments and prefer owing risky assets such as Equity & Crypto.

That’s it about Fixed Income Instruments. Hope this video helps you in your future investment decisions. 

Conclusion:

Fixed income instruments, or fixed-income securities, are a type of investment that pays a fixed rate of interest and eventually refunds the primary investment bond’s money at the bond’s maturity. 

In contrast to other variable-income instruments, the payments on fixed-income options are known in advance. Fixed income securities provide investors with a steady stream of periodic interest payments at a fixed rate (known as coupon payments). 

Municipal bonds are the most frequently purchased fixed income products and are available in the form of municipal bonds, government bonds, and corporate bonds. However, not all fixed-income investments are made equal. 

Bonds are rated using a variety of characteristics, and these ratings can impact a bond’s viability. These factors include interest rate risk, credit risk linked to individual bonds, and the company that makes the bonds.

Fixed-income securities are financial products that pay investors a predetermined rate of interest in the form of coupon payments. Interest is normally paid semi-annually while the principal invested matures and is returned to the investor. 

Bonds are by far the most prevalent type of fixed-income security. Businesses raise funds through the sale of fixed-income securities to investors.

A bond is an investment product that firms or governments issue to obtain capital for specific projects or activities. Bonds are primarily comprised of corporate and government obligations and come in a variety of maturities and face values. 

The face value of a bond is the amount that the investor will receive at maturity. Corporate and government bonds are often listed on major markets.

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