All You Need to Know About Fixed Income Securities

There are different types of investment alternatives available that differ in their structure and eventual functioning. Some come with a fixed income guarantee whereas in some cases, return is not fixed and depends on several underlying factors. 

Fixed income securities are a type of investment instrument that comes with a definite income in the form of periodic interest payments. Moreover, investors also receive the principal amount invested on maturity. Read here to know more about the working details about this concept and how you can productively use them for maximising gains.

What are fixed income securities?

As the name suggests, these securities are those that come with a fixed income. The most notable example of these types of securities is bonds. 

The return component on these remains fixed and does not change like variable income securities. It is a legal obligation for the issuers to provide periodic returns on these instruments in the form of interest payments without fail. 

Furthermore, issuers of such instruments do not have the power to change the terms and conditions associated with fixed returns irrespective of what is happening in the market. 

The final amount that the investor shall receive from these securities at the time of redemption is predetermined. Investors get to know this final amount at the time of the issue itself. 

These instruments are ideal for those set of investors who are seeking periodic returns from their investments at low or minimal risks. Now that you are well aware of the meaning of fixed income securities, let’s move our attention to other aspects of the same. 

How do fixed income securities work?

Fixed income refers to the fixed interest payment that investors receive from such securities. It's dependent on the credit rating of the issuing entity as well as the prevailing market interest rates. In general working, it has been seen that fixed-income instruments like bonds offer high interest rates to their borrowers if it has a long tenure. 

Therefore, in case of fixed income securities, the interest rate is directly proportional to the maturity or redemption period. The longer the duration period, the higher will be interest rate and vice versa. The only reason behind this rationale is that borrowers would be ready to pay higher interest rates if investors or lenders offer a longer timeline for returning the money. 

At the end of the investment duration, borrowers repay the full principal amount that they had taken from lenders. 

How do fixed income securities work?

Now, let's see an example which will further clear out your understanding regarding this concept. Suppose you decide to invest in a government bond which is a fixed-income security. The price of the respective government bond stands at ₹15,000. The interest rate on this bond stands at 5% and the total maturity period is 10 years. 

The coupon or interest payments will be given on a half-yearly basis. If you decide to buy out this type of bond, you will have to pay ₹15,000 to the government on an upfront basis. Moreover, you shall receive ₹750 twice a year as the interest payment cycle is half yearly. 

The government will continue to give out the interest amount to you for a period of 10 years which is the maturity cycle. After the completion of maturity period, government will repay the full ₹15,000 that it had received as an upfront payment from you. 

Different types of fixed income securities

Here are the different types of fixed income securities in which you can invest in: 

• Asset backed securities 

These instruments are popular as they function as a perfect substitute for corporate debt instruments. As the name suggests, these instruments are backed with certain high quality assets like credit card receivables, home or equity loans, etc. 

A centralised regulatory authority is responsible for thoroughly examining such assets and creating a central pool or basket of assets for leveraging purposes in these kinds of fixed income instruments. 

• Treasury bills 

These instruments are issued by various governments to raise money for meeting their expenditure. It comes with a maturity period of one year. Governments generally issue these bills at a discounted value but repay at par value. The difference between the two acts as profit for investors. 

• Certificate of deposits 

Also known as fixed deposits in common parlance, banks and other financial institutions issue these certificates to people who keep money in their institution for a certain time period. Banks also provide regular interest income to depositors. 

Generally, the rate of return in a certificate of deposits is not quite high. However, it is higher than a savings account, so you can look to put your money in these instead of parking funds in a normal savings account. 

• Treasury notes  

These instruments have an expiry period between two and ten years. Usually, it is the prerogative of governments to issue such instruments. Interest payments on these instruments occur in a half yearly manner. 

Moreover, issuers repay back the full principal amount on maturity. Compared to other instruments like corporate bonds, these are relatively safer as it comes with a sovereign guarantee and is heavily regulated by central regulatory authorities.  

• Government securities 

It comes with a tenure of five to forty years. These securities also have an interest payout on a half-yearly basis on the face value of these securities. 

• Public provident fund 

This is a central government-sponsored fixed income security. It offers interest on an annual basis on the total amount invested in the security. It is quite beneficial as it not only offers interest income but also facilitates tax benefits for investors. The interest on these schemes is quite higher than in other similar schemes. 

• National savings certificate 

Another example of fixed income security is the national savings certificate or NSC. You can buy these from your nearby post office. The national saving certificate can be available in your name and there is a joint option as well in case of a minor. It offers fixed interest income for investors, and it is quite high than other traditional savings schemes. 

It comes with a maturity period of either 5 years or 10 years. The minimum amount in these certificates is ₹100 and it offers tax benefits up to ₹1.5 lakh under section 80C of the Income Tax Act 1961. 

Who should invest in fixed income securities?

As the name suggests, these instruments offer a relatively risk-free fixed income for their investors. Therefore, it becomes an ideal investment alternative for conservative investors who are contend with moderate returns. These investors are wary of the fluctuations occurring in equity and related instruments and do not want to risk their hard earned money in that. 

Moreover, if you are looking to diversify your portfolio, these securities can be a good investment option. This is because it will provide a stable flow of income even when other investments of your total basket suffer some setbacks or do not yield sufficient returns. 

One downside of investing in these is that it reduces the real value of money. This is because there is no protection and adjustments made against inflation. Therefore, if you are looking to invest in this security, it is imperative that you look out for your investment goal, risk appetite and prevailing market conditions before taking a decision.  

Benefits of investing in fixed income securities

Some benefits of fixed income security investment are as follows: Regular returns One of the biggest advantages of investing in these instruments is that it provides a regular and consistent income for the investors. This helps investors to better plan their different financial activities as they are sure of a certain return from these instruments. It offers certainty and surety in financial planning and management. Portfolio diversification These securities go a long way in diversifying the investment basket of some classes of investors. Incorporating these instruments in your investment basket helps in maintaining a balance of your investment basket. This is because there exists an inverse relationship between returns from equity instruments and fixed income instruments. Therefore, if returns from equity go down, these fixed securities will be your saviour and prevent a degradation of your investment portfolio. Low risk When compared with other investment instruments like equities, derivatives, real estate, and mutual funds, fixed income securities score lower on the risk factor. They come with the least risk as compared to all the above mentioned instruments. As a result, it becomes quite an ideal investment instrument for those investors who are wary of market fluctuations and content with moderate to low returns. Credit rating All fixed income instruments come with a credit rating given by an independent and impartial credit rating agency. These credit ratings help investors to make an informed decision based on the creditworthiness of the respective issuing entities. Preference in case of insolvency Another benefit of these instruments is that creditors of these income securities will be given first preference in terms of repayment whenever the issuing entity undergoes insolvency proceedings. Therefore, it acts as another safety net that even if the corresponding organisation collapses, there is still a way of minimising overall losses.

Disadvantages of investing in fixed income securities?

Although these instruments are quite beneficial for investors due to a number of benefits arising from the same, there are some drawbacks as well. 

• Interest 

As the interest income from these instruments is fixed, investors of these instruments may miss out on the benefits of rising market interest rates. When the interest rates of new securities increase, existing securities become less lucrative for investors. They will opt for putting their money in new securities rather than older ones at low interest rates. 

Hence, due to changes occurring in interest rate scenarios, existing securities may find it difficult to stay competitive and become redundant quickly. 

• Low liquidity 

The liquidity of these fixed income instruments is lower than that of equity and related instruments. It becomes difficult to find a new buyer or seller and carry out transactions because there are several things that affect the functioning of fixed income securities. This includes general market interest rates, the credibility of such securities, terms of repayment, etc. 

Things to consider before investing in fixed income securities

Here are some things that you can consider before investing your hard earned money in these instruments: 

• Investment goals 

It is important that you consider your investment objectives and analyse whether it is aligned with what the fixed income security is offering. Only if you are satisfied that the concerned fixed income security is in sync with your overall investment goals, you should think about investing in it. 

• Risk appetite 

Another thing that you may consider is your risk appetite. These instruments are ideal for low risk or conservative investors. Investors that have a high-risk tolerance level might not prefer this investment instrument because of its limited returns. 

• Credibility of issuing entity 

Another thing that you need to look into is the credibility or creditworthiness of issuing entity. You should consider investing in only those securities that have a high credit rating or which are issued by entities with high credibility in the industry. 

Conclusion

Fixed income securities are efficient financial instruments that provide safe and guaranteed income for investors. It is quite popular among conservative investors who are looking for a nominal but stable flow of income. If you are looking to invest in these securities, you should carry out a thorough market analysis and decide on the instrument after due diligence and consideration.