What is a Fixed Income Security
Fixed Income Security which is an investment that provides periodic interest payments and returns of principal at maturity. Unlike any other variable –income securities such as short term interest rates the payments of a fixed-income security are known in advance.
The most common type of Fixed-Income Security is a bond that promises to make a series of interest payments in fixed amounts and to repay the principal amount at maturity. There is an inverse relationship between the market interest rate and the value of the bond. If the interest rate increases the price of the bond decreases. Bonds Rating are based on their relative probability of default because investors prefer bonds with lower probability of default, bonds with lower credit quality must offer investors higher yields to compensate for the greater probability of default will decrease the price of the bond thus increasing its yield.
Features of a Fixed Income Security
The features of a fixed income security include specification of :
- The issuer of the bond
- The maturity date of the bond
- The par value (principal value to be repaid)
- Coupon Rate and Frequency
- Currency in which payments will be made
Bonds are mostly comprised of Corporate Bonds and Government Bonds and can have various maturities and face value amounts. A prime example of Sovereign National Government bonds is US Treasury Bonds but many countries issue sovereign bonds
Types of Fixed Income Security
Treasury Notes(T notes) are issued by the U.S Treasury and are intermediate-term bonds that mature in two, three, five or 10 years. T-notes have a face value of $1000 and pay semiannual interest payments and principal repayments of all treasury are backed by the US Government. Another type of fixed income security is Treasury bonds (T-bonds ) which matures in 30 years.
Bond Maturity date is the date on which the principal is to be repaid. Once a bond has been issued, the time remaining until maturity is referred to as the term to maturity or tenor of a bond.
When bonds are issued, their terms to maturity range from one day to 30 years or more. Both Disney and CocaCola have issued bonds with original maturities of 100 years. Perpetual bonds are the bonds which have no maturity date. There is another short term fixed income securities include Treasury Bills. T-bills mature within one-year issuance and doesn’t pay interest. Investors are paid the face value amount when the bills mature. The interest earned or return on the investment is the difference between the purchase price and the face value amount of the bill.
The principal amount that will be repaid at maturity is called the par value of a bond.
The coupon rate on a bond is the annual percentage of its par value that will be paid to bondholders.
Bonds are issued in different currencies. A dual Currency bond makes coupon interest payments in one currency and principal repayment at maturity in another currency.
Money Market Instruments
Money Market Instruments include securities such as commercial paper ,banker’s acceptance ,certificate of deposit(CD),and Repurchase agreements(“repo”).Treasury bills are technically included in this category, but due to the fact that they are traded in such high volume, they have their own category here.