Fixed Income Investment

What is FI investment? Fixed-income investments protect capital, are less susceptible to market fluctuations and geopolitical events, so they generally carry lower risk than stocks, and in some cases provide tax exemption. Typically, fixed income investments include:

Government bonds

Corporate bonds

Certificates of deposit (CDs)

Main features With fixed income investments, investors know exactly how much money they will receive monthly, quarterly, semi-annually or annually and when they will get their principal back at maturity. Holders of corporate bonds have a higher claim on a company’s assets than holders of common stock if a company declares bankruptcy or liquidation.

Attributes of bonds include:

Face value: Also known as “face value” or “par”, it is the amount payable to the investor when the bond matures; most bonds are issued in increments of $1,000.

Coupon rate: The yield paid on the face value of the bond.

Maturity: The time until the bond’s maturity date.

For example, an investor who purchases a $10,000 bond with a coupon rate of 5% and a five-year maturity will receive five coupon payments of $500 each year and a return on his initial investment at the end of the fifth year. The total return will be:

10,000$ * 5% = 500$

$500 * 5 = $2500

$10,000 + $2,500 = $12,500

Different types

Treasury Bonds (Government Bonds)

Treasury bills, notes, bonds are government debt securities with an “X” maturity issued by the government. These contracts earn periodic interest until maturity, at which point the owner is also paid a nominal amount equal to the principal.

Treasury bills (T-bill): They mature in less than a year and do not pay coupon returns, their interest is repaid at maturity.

Treasury notes (T-note): Matures in 2, 3, 5, or 10 years, pays interest every six months, and is sold in multiples of $100.

Treasuries (T-bonds): Have maturities of 10 to 30 years, pay regular interest, and come in multiples of $100.

Corporate Bonds

A corporate bond is a debt instrument issued by a company to raise its capital. An investor who buys a corporate bond actually lends money to the company in return for a series of interest payments, but these bonds can also be actively traded on the secondary market.

Treasury Inflation-Protected Securities (TIPS)

An inflation-linked bond is a bond in which the payment of interest income on the principal is related to a specific price index, usually the Consumer Price Index (CPI). This feature provides investors with protection against changes in inflation. The cash flows of the bond are adjusted to ensure that the holder of the bond receives a known real rate of return.

Municipal Bonds

Debt securities issued by states, cities, counties and other government agencies to finance projects such as highway or school construction. Municipal bonds can have maturities ranging from one year to 10 years.

Interest on municipal bonds is generally exempt from income tax and may be exempt from local taxes if the buyer of the bond resides in the state in which the bond was issued.

Deposit Certificates

Federally insured bank deposits that pay a specified amount of interest for a specified period of time, such as six months, one year, 18 months, three, or six years. They are offered by banks, credit unions, and brokerages, and CDs carry FDIC or National Credit Union Administration (NCUA) protection of up to $250,000 per person.

CD interest rates are generally higher than those offered by banks on savings and money market products. Typically, there are early withdrawal penalties (EWPs) for withdrawing money from a CD before the maturity date.

Fixed income ETFs

Exchange-traded funds (ETFs) are a type of pooled investment instrument similar to a mutual fund that tracks an index, industry, specific commodity, or other asset. What distinguishes ETFs from mutual funds is that they are traded on an exchange.

A fixed income ETF includes government bonds, corporate bonds, municipal bonds and local bonds.

While the underlying instruments, the bonds themselves, have a maturity date, a bond ETF does not have a maturity date, but is instead traded at a premium or discount from the actual price of the bonds. The first ETF was the SPDR S&P 500 ETF, which tracks the S&P 500 Index and remains an actively traded ETF today.

Green bonds

A green bond is a type of fixed income instrument designed specifically to raise money for climate and environmental projects.

These bonds are typically asset-linked and backed by the issuer’s balance sheet, so they often carry the same credit rating as their issuers’ other debt obligations. Green bonds allow for raising capital and investment for new and existing projects with environmental benefits.

The Green Bond Principles (GBP) aim to support issuers in financing environmentally sound and sustainable projects that promote a net zero emissions economy and protect the environment.

Financial markets can help solve the climate challenge by meeting the growing demand for low-carbon projects around the world, from urban transport infrastructure to renewable energy facilities. New financial instruments such as green bonds are helping to attract more capital to these projects. Clear standards and better market data will accelerate adoption, making green bonds an even more attractive way to invest.

Green bonds are growing. Newly issued green bonds and world regions with the highest emissions (in billion euros)

Risks and benefits

Benefits

Diversification: Fixed income investments can help offset losses that occur when the stock market fluctuates.

Conserving capital: Investing in fixed income securities can help protect an investor’s capital.

Income generation: Coupon payments on bond investments provide a steady stream of income at regular intervals, and income from many government bonds is tax-free.

Risks

Interest rate risk: When interest rates rise, bond prices fall, the value of bonds an investor holds will be lower.

Inflation risk: Bonds pay a fixed interest rate at regular intervals, but if this rate is lower than the inflation rate, the bondholder loses purchasing power.

Credit risk: If a bond issuer goes through tough times and cannot meet their debt obligations, bondholders may not be able to get the full value of their principal.

Liquidity risk: If something happens suddenly and the bondholder has to sell his fixed income asset, he may not be able to find a buyer.

How does bond price relate to yield? Bond price and bond yield are inversely proportional. The higher the price of the bond, the lower the yield. As the price of the bond falls, the yield increases. This is because the bond’s coupon rate remains constant, so the price in the secondary markets often fluctuates in line with prevailing market rates.

When interest rates in the market rise, there are more investment options to earn higher interest rates. A bond issuing a 3% coupon payment may now be “outdated” if interest rates rise to 5%. To compensate for this, the bond will be sold at a discount in the secondary market. Although the coupon rate will remain at 3%, the bond’s lower price means the investor will earn higher returns.

If you’re an investor looking to get into bond investing through secondary markets, you can most likely buy a discounted bond. If you’re holding an older bond and its yield is increasing, it means that the price you paid is lower than market conditions. However, you still earn a coupon rate on your initial investment.

In addition, high yields are directly proportional to the risk of the bond. You can get a very high return for a junk bond, but that doesn’t mean it’s a good investment. Generally, higher yields reflect more risk for bonds. For risk-averse investors looking for safer investments, a lower return may actually be preferable.

Conclusion? Fixed income is an investment approach that focuses on maintaining capital and income. It often includes investments such as government and corporate bonds, CDs and money market funds. Fixed income can offer a steady stream of income with less risk than stocks.

Kaynak Enver Erkan / Tera Yatırım
Hibya Haber Ajansı