Fixed Income Security
Fixed Income Security is a type of debt instrument in which the issuer is liable to pay fixed income with a fixed interest rate to the investor. At the time of the purchase of these securities, a rate of interest is fixed, to be provided to the investor at the time of maturity. Under this type of instrument, the return is generally low because the risk associated which fixed-income security is very less, and because of this the return is also comparatively low. Fixed Income Security is mainly issued by the government, companies, and corporations to manage their cash flow.
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Under long-term fixed-income investments, the interest payment is made on the principle amount at a fixed interval and on the date of maturity, the principal amount is returned to the investor. Under short-term fixed-income investments, the interest amount is added to the principal amount on the maturity date and investors can redeem their investments.
Types of Fixed-income security:
- Bank Fixed Deposit: Fixed Deposit is the most common instrument offered by scheduled banks in which any person can deposit their money for a particular period of time and can earn interest on it and the returns will be given to the investor with their principle amount on the time of maturity. Before the date of maturity investors cannot withdraw them from the bank. Fixed Deposits are available with a maturity period of 7 days to 10 years. This is the most secured instrument with fixed interest income as they are issued by regulatory banks. The rate of interest can differ from one bank to another and on the basis of the time duration, an individual is willing to invest.
- Treasury Bills: Treasury Bills which are also known as T-bills are mainly issued for short-term investment by RBI or the central bank of any country to raise the short-term funds for the government. Generally, T – bills are issued for 91 days, 182 days, and 364 days in the multiple of Rs. 25,000 by RBI. Basically T- bills are issued at discount on the face value and on the date of maturity investors can redeem it on its face value. So, the difference in the amount between the purchase value and redeem value is the return earned by an investor.
- Bonds: Bonds are issued by both government and corporate to meet their funding requirements. When companies would not like to take loans from banks and pay high-interest rates; they offer bonds to the public to manage their cash flow. Government bonds are said to a secured investment. The rate of interest is fixed and the interest amount and principal amount are paid on the date of maturity.
- Certificate of Deposit: Certificate of Deposit is mainly issued by banks, financial institutions, and credit unions. This is a type of saving certificate in which a fixed amount of return is generated to investors on their investment after a specific period of time. As these securities are backed by the government they are less risky. This instrument is similar to a fixed deposit but the interest rate is comparatively high than that of a fixed deposit but as to bonds, the interest rate is low.
- Recurring Deposits: Recurring Deposit is a type of investment in which any individual can invest for 1 to 10 years in various installments and can earn fixed interest on that amount of various installments.
- Municipal Bonds: Municipal Bonds are issued by the government in various cities, states, and even in the country for funding various projects undertaken by the government for the development of infrastructure, roads, etc. in the county.
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Benefits in Fixed-income Security:
- Consistent Returns: One of the most important advantages of investing in fixed income securities is the consistency of returns they provide over time.
- Low risk of price volatility: Fixed income is considered to be less risky than stocks because it is less susceptible to macroeconomic variables like market crises and geopolitical tensions.
- Investment Protection: Since some of these instruments, such as treasury bills or government bonds, are guaranteed by the government, the risks of defaulting on interest and principal payments are almost zero when opposed to equities.
Risks involved in Fixed-income Security:
- Interest rate risk: Bond prices decline as interest rates increase, reducing the value of the bonds you own. Price instability in bond markets is primarily caused by interest rate shifts.
- Credit risk: These securities are subject to credit risk, which means that the issuer can fail to make interest payments or repay principal.
- Inflation risk: Bonds provide regularly a set amount of income but if the inflation rate surpasses this fixed level of income, the investor loses buying power.
- Low Returns: They usually offer a lower rate of return than equities or other types of investments.
Example:
Let’s say an investor invests Rs. 10,000 in fixed deposit in the bank and annual fixed return is 7% and he invested it for 5 years thus every year he will generate a return of Rs. 700 and at the end of 5 years, his investment will be valued a Rs. 13,500.
Key Takeaways:
Fixed Income Security is mainly issued and purchased to maintain the cash flow by the government and companies. Companies also invest in various instruments for the short-term to earn a return on the investments that are not going to be used for a short period of time. Investors mostly preferred to invest in this security because they are safe and secured and return is also guaranteed to be earned. Investors with low disposable income mostly invested in fixed income security and individuals with high disposable income invest a low portion in fixed income security.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing MBA with a specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated by the financial markets.
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