What is Fixed-Income Security?

If you are active in the Indian financial market, the main thing you must ensure is your portfolio health. The main driving force behind ensuring positive portfolio health is diversification. Investors know that if they allocate all of their capital to a single asset class, they critically raise the chances of incurring losses. Hence, they diversify across various asset classes in a way that lowers their risk profile and allows them to earn a steady income.

If you know you are going to earn a specific amount after a predetermined amount, you can raise your risk appetite and invest in volatile securities. This process of diversification is widely used by investors who give utmost importance to their portfolio health. However, the technique of investing such that you earn a fixed income is extensive and requires a deeper understanding. Through this blog, you will understand the method used by investors to earn a fixed income. The assets utilised are called Fixed-Income Securities, and the technique is called Fixed-Income Trading.

What are Fixed-Income Instruments?

Fixed income instruments are those financial instruments that come with fixed interest or dividend payouts to the investors until their maturity dates. After the maturity date, the instrument creator generally repays the principal amount that was initially invented back to the investors. Under fixed-income instruments, the intervals at which the payouts are made and the amount of payouts is predetermined, meaning that investors know beforehand how much and when they will be paid.

Corporate and government bonds are the most common and widely traded fixed income instruments. Bonds are debt instruments, which implies that they work on the principle of loans, where a company issues bonds to borrow money from the lender, also called the bondholder. The company promises the lender a regular predetermined interest on the principal amount. Apart from corporate and government bonds, investors can invest in several fixed-income mutual funds and fixed-income Exchange-Traded Funds.

Understanding Fixed-Income Instruments

Investors who want to take higher risks in the financial market believe that it can give them better returns. However, they are always fearful about the risk involved. To counter this fear and ensure they have a steady income to cover personal expenses, they look towards understanding fixed-income security meaning and investing in them systematically.

For example, you can invest in a government bond that is priced at Rs 20,000 and has a coupon rate (interest rate) of 4%, a maturity period of 10 years and a semi-annual payout cycle. Once you buy the bond, you will have to pay an upfront amount of Rs 20,000, which will go to the government. You will receive two interest payouts in a year of Rs 800 as the payout cycle is semi-annual. These interest payouts will continue till the maturity period, i.e., ten years. Once the maturity period is over, you will get your principal amount of Rs 20,000 back from the government.

Types of Fixed Income Securities

Fixed-income security may vary in its type depending on its features and the process used to provide returns to the investors. Some of the most widely invested fixed income securities are listed below:

• Asset-Backed Securities: These types of fixed income securities are an alternative to corporate debt instruments and are backed by assets such as auto loans, home-equity loans, credit card receivables etc. The underlying financial assets are regulated and securitised by a central authority to create a basket of such assets as a single fixed-income security.

• Treasury Bills (T-Bills): Treasury bills are issued by the government and mature within one year. These bills do not offer a fixed interest payment but offer returns at maturity by allowing investors to buy the bills at a lesser rate than the face value. For example, you can buy a treasury bill with Rs 100 face value at Rs 98 and get a return based on the difference between the face value and the issue price.

• Municipal Bond: These are generally issued by a state government to fund the state’s capital expenditure, such as building schools, roads, hospitals, etc. They provide a fixed interest payment to the investor, which is tax exempted in most cases. Municipal bonds also promise to pay back the principal amount to the investors and come with various maturity dates starting from months to several years.

• Treasury Notes (T-Notes): Treasury notes are issued by the government and come with a maturity period between two and ten years. They provide a semiannual interest payout and repay the principal amount at the end of the maturity period. This type of fixed-income security is considered to be the safest as it is fully backed by the government and is regulated by the central financial authorities.

• Certificate of Deposit: Certificates of Deposit (CDs) are a type of fixed-income security that is issued by banks to offer regular interest payments to depositors who deposit money in the bank. A CD has a lower interest rate than banks but is utilised as they pay better interests than a saving account.

• Dated G-secs: This type of fixed-income security comes with a fixed or floating interest rate paid on the instrument’s face value. The interest is paid on a half-yearly basis. Generally, the tenor of dated G-securities ranges from five years to forty years.

Benefits of Fixed-Income Securities

Investors choose fixed-income securities as they come with numerous benefits including:

• Steady Income: If you invest in fixed-income security that comes with a regular interest payout, the issuer is legally bound to pay you the interest amount at predetermined intervals. It allows earning a steady income, with the promise of getting a prespecified amount, irrespective of the market conditions or the current trend.

• Diversification: Fixed-income securities can be used to diversify your portfolio and ensure the effective management of the risk-return factor in your investment portfolio. Furthermore, investors can increase their overall risk appetite and invest in other high-risk investments by investing in fixed-income trading instruments to increase profit potential.

• Risk Factor: Unlike other asset classes that are volatile in nature, fixed-income securities are less risky in nature. You are paid a predetermined amount regardless of the market conditions, reducing your risk factor by a huge margin. Furthermore, as most of these securities are backed by the government, it makes them relatively safer to invest in.

• Ease of trading: You can invest in fixed-income securities just as you buy and sell other financial instruments. These securities can be traded through a stockbroker using a demat and trading account. Furthermore, you can also invest in fixed-income securities in the form of fixed-income mutual funds or fixed-income Exchange Traded Funds.

• Credit Ratings: All fixed-income securities are rated by various credit rating agencies based on their risks and rewards. It allows investors to evaluate fixed-income security, understand the creditworthiness of the issuer, and invest in financially stable securities.

Final Words

By investing in fixed-income securities, you can ensure effective diversification and make your portfolio healthy. However, it is always advised that you check the credit ratings of every fixed-income security before you invest, as it will further lower the risk factor. To learn more about the fixed-income security definition and how you can invest in them, you can visit IIFL’s website or download the IIFL Markets app from the app store.