What is Fixed Income Trading?
An Indian financial market is an effective place for investors, irrespective of their financial goals. However, the principle of high-risk high returns is a contributing factor across all financial instruments, yet the decisions depend entirely on the investors’ risk appetite.
Investors with a higher risk appetite tend to invest in instruments such as equities that can offer them high returns but with a high-risk potential. The other type of investors who have either allocated a portion of their capital to high-risk instruments or have a low-risk appetite look towards a trading technique called Fixed Income Trading. This lowers their risk factor and earns steady returns over time.
This blog will detail everything you need to know about fixed-income trading and how fixed-income trading works.
Fixed-Income trading is a trading technique in which investors buy fixed-income instruments that come with a regular interest or dividend payout. Unlike equities that come with high risk and inconsistent returns, fixed-income trading instruments allow investors to earn steady returns as creators are legally bound to pay the investors at regular intervals.
Under fixed-income trading 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. Apart from corporate and government bonds, investors can invest in several fixed-income mutual funds and fixed-income Exchange-Traded Funds.
What are Fixed-Income instruments?
Fixed income instruments are those financial instruments that come with fixed interest or dividend payouts to the investors until the maturity date. Once the date arrives, the instrument creator generally repays the principal investment amount to the investors.
Corporate and government bonds are the most common and widely traded fixed income instruments among numerous 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.
Understanding Fixed-Income Trading
All the fixed-income trading instruments are debt securities that companies and governments issue to raise money from the public. In return, the investors are promised regular predetermined interest or dividend payments regularly. Furthermore, all fixed-income trading instruments come with a maturity date that may be after a few months or years. After maturity, the investor gets the principal amount back.
For a better understanding, consider the following example for a fixed-income trading instrument:
Suppose you buy a bond with 5% interest and Rs 10,000 face value and a maturity date of five years. Your initial investment will be Rs 10,000, and you will receive this amount only after the end of five years. Until maturity, you will receive interest payments, called coupon payments, annually (can be monthly, quarterly, or semiannually). Since the coupon rate is 5%, you will receive Rs 500 as the interest payment every year. In total, you will receive Rs 2,500 over five years. After the maturity date, the initially invested Rs 10,000 will be returned to you.
Types of Fixed-Income Products
Here are the types of most common fixed-income trading products:
- Fixed-Income Mutual Funds: These types of Mutual Funds invest in various other debt instruments and bonds. As these funds are professionally managed, it allows investors to benefit from the experience of professional portfolio managers.
- Fixed-Income ETFs: These ETFs work identically to other Mutual Funds and target specific durations, interest rates, credit ratings, etc. They are managed by portfolio managers.
- Corporate Bonds: Corporate Bonds are offered by companies that want to raise funds from the public. These come in numerous types, and the interest rate offered fluctuates depending on the company’s financial condition and creditworthiness.
- Treasury Bills (T-Bills): These 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.
- 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.
Advantages of Fixed Income Trading?
Here are the advantages of fixed-income trading instruments:
- Steady Returns: Fixed-Income trading instruments earn investors a steady stream of income because of the regular predetermined interest or dividend payouts. As the payouts are predetermined, investors know how much they can earn and at what time.
- Repayment: Almost all fixed-income trading instruments come with the option of repayment where the investors are repaid in full, what they invested initially to buy the instrument.
- Diversification: Fixed-income trading instruments make one of the most effective ways to diversify and manage the risk-return factor in their investment portfolio. Furthermore, investors can increase their overall risk appetite and invest in other high-risk assets by investing in fixed-income trading instruments to increase profit potential.
- Negligible Volatility: Unlike equities, currencies, and commodities, fixed-income trading instruments do not fluctuate and experience volatility. These instruments come with a predetermined interest rate which does not change depending on the market factors. As the issuer is legally bound to pay, investors are guaranteed the interest payments.
- No risk: One of the best advantages of fixed-income trading instruments is their capability to reduce the risk to a negligible level. As many of these fixed-income trading instruments are backed by the government, it makes them one of the safest financial instruments an investor can buy and earn guaranteed returns.
Fixed-Income Trading allows investors to earn steady and guaranteed returns on their investments and mitigate their risk by a huge margin. The best way you can use fixed-income trading instruments is by allocating a portion of your capital towards such instruments and investing the remaining in high-profit potential instruments. A portfolio including high-risk and low-risk financial instruments is considered an ideal portfolio made possible only through fixed-income trading instruments.
Frequently Asked Questions Expand All
Corporate fixed-income trading instruments come with credit and default risk if the company goes bankrupt. Furthermore, if the company is financially struggling, the prices of the instrument may decline in value in the secondary market.
Fixed-income traders work for banks or stockbrokers and execute trades on behalf of retail and institutional clients. They may take a commission per trade or draw a salary based on their skill and experience.
In India, fixed-income traders generally earn well, starting from Rs 7 lakhs per year that increases with skill, performance and experience.