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 the 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 for 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-income 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.
Example of Fixed Income Investments
There is a company that issues a 6 % coupon bond 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 $ 1,000 in the bond and will redeem it at the end of three years period only. Now, since the company has issued the bond 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.
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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 firstly 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 so he will be getting the same rate or returns till the 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 market. 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, reinvestment risk, prepayment risk, and the 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 the period of time. Fixed-income instruments are used commonly 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 capital. During the time of economic downturn in the market, investors rely on these asset classes 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 –