What is Fixed Income Investment?
Fixed Income Investment is a type of investment in which the investor is provided with the income which is fixed and relatively stable over a period of time in the form of dividends or interests. Under the fixed-income investments, the borrower or the issuer of the securities is obliged to the payments of the fixed amount on the fixed specified schedule. These fixed investments are generally issued by the companies and the governments in the form of the debt securities for raising the money to fund their day-to-day operations and also to finance large projects.
From the perspective of the investors, if they invest their money in these fixed-incomeFixed-incomeFixed Income refers to those investments that pay fixed interests and dividends to the investors until maturity. Government and corporate bonds are examples of fixed income investments. investments, then they will get paid the set interest rate, which is fixed in exchange for the money which is given by them to the issuer of the investments. The fixed payments received are known as the coupon payment and the date when the investors will be repaid. The original amount (principal amount) invested by them is known as the maturity date.
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Example of Fixed Income Investments
There is a company that issues a 6 % coupon bondCoupon BondCoupon bonds pay fixed interest at a predetermined frequency from the bond’s issue date to the bond’s maturity or transfer date. The holder of a coupon bond receives a periodic payment of the stipulated fixed interest rate. having a face value of $ 1,000 with a maturity period of three years paying interest annually. Joseph, an investor, wants to invest his money amounting to $ 1,000 in the bond and will redeem it at the end of a three years period only. Now, since the company has issued the bondBondBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period., it will have to pay the interest at the rate of 6 % annually to all the investors.
These interest payments are the fixed income, which will be received by all the investors in the bonds of the company and are also known as the coupon payments. As a result, Joseph will be paid $ 60 per year ($ 1,000 *6 %) for three years till the time for the maturity of the investment, and at the time of maturity, Joseph will be repaid the $1,000 which was initially invested by him for purchasing the bond.
The payment of these fixed incomes on the investments can be done monthly, quarterly, semiannually, annually, or as per the terms and conditions of the bond as decided at the time of issuing it.
Advantages of Fixed Income Investments
There are several different advantages of fixed-income investments providing the opportunity for the investors and the issuer of fixed-income securities. Some of the advantages are as follows:
- Regular Income: This income investment provides the regular income, which will be given for sure during the specific time period as decided before making the investment.
- Priority at the time of Liquidation: Whenever there arises the situation of liquidation of any company, then the people having the fixed income securities will be given priority over the other securities issued by the company. For example, if there are bonds and equity issued by the company and the company goes for liquidation, then companies will be required to pay for the bonds first prior to payment to its shareholders for their equity share.
- Safe deal: In most cases, fixed income securities have the specific date of maturity when the amount invested will be returned back to its investors, which is already decided at the time of issuing those securities. So, the issuer of the fixed securities is obliged legally to return the money back to the investor on that date; otherwise, he would be liable to the legal action if the complaint is filed by the investor.
Disadvantages of Fixed Income Investments
Along with the advantages of the fixed-income investment, there are some disadvantages or limitations as well of the same, which are as follows:
- Interest rate risk: Fixed income investments are subject to the interest rate risk. This risk arises when the interest rate in the market in which the person has invested rises. Now, as he has already invested at the fixed rate, he will be getting the same rate or returns till maturity even though he can get more interest-paying securities at the same level of investment. He cannot invest in the new securities paying high returns because his money is already locked.
- Credit Risk: If, due to some internal or external factors, the position of the company in which the investor has invested his money declines, then the value bond or instrument of that company will also decline in the secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.. Now, if the investor tries to sell the instrument before its maturity, then he might get the low prices, or he might even find it difficult to sell it before maturity.
- The main focus of the fixed income investment is on generating a fixed amount of income to the investor and not on the appreciation of the capital.
- The fixed-income investments are also considered when preparing the portfolios as they help in keeping the return stable whenever any adverse situations arise in the market.
- These investments are subject to various types of risks such as interest rate risk, credit risk,Credit Risk,Credit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection. reinvestment riskReinvestment RiskReinvestment risk refers to the possibility of failing to induce the profits earned or cash flows into the same scheme, financial product or investment. It even states the uncertainty of not getting the similar returns when such funds are invested in a new investment opportunity., prepayment riskPrepayment RiskPrepayment Risks refers to the risk of losing all the interest payments due on a mortgage loan or fixed income security due to early repayment of principal by the Borrower. This Risk is most relevant in Mortgage Borrowing which is normally obtained for longer periods of 15-30 years., and liquidity risk, which should be considered by the investors before making the investment in the fixed income instruments.
Thus fixed income investment is an investment where the investor invests his money and gets the income, which is fixed in return and stable over a period of time. Fixed-income instruments are commonly used for diversifying the portfolio of the investor, as the fixed income investment being safe in nature when compared with other securities, helps in reducing the overall risk associated with the portfolio.
Fixed-income securities are more stable in nature when compared with the pure equity holdings, and the main focus of the fixed income investment is on generating the fixed amount of income to the investor and not on the appreciation of the capitalAppreciation Of The CapitalCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.. During the time of economic downturn in the market, investors rely on these asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples. more than any other type of investment.
This has been a guide to what is Fixed Income Investment and its definition. Here we discuss the example of fixed-income investments along with the advantages and disadvantages. You can learn more about fixed income from the following articles –