What is a Fixed Income Market?
Fixed Income Market is a market that trades fixed income securities like government bonds, corporate bonds, and treasury bills. In this market, the investors receive a regular income – on a monthly, quarterly, half-yearly, or yearly basis – and repayment of principal amount on maturity.
Table of contents
- What is a Fixed Income Market?
- Types of Fixed Income Securities in Fixed Income Market
- Example of Fixed Income Securities
- Recommended Articles
- A fixed income market refers to a market where fixed income securities are traded such as government bonds, T-bills, corporate bonds, etc.
- There are various types of fixed income securities such as bonds, money market instruments, treasury bills, etc.
- There lies a criterion for the existence of a fixed income market such as who issues the fixed income securities, the creditworthiness of the issuer, the maturity period, types of coupon rates, etc.
- Fixed income markets benefit investors in ways of regular income, less risk, and liquidation. A few disadvantages of fixed income markets are credit risk, inflation rate, interest rate risks, etc.
Types of Fixed Income Securities in Fixed Income Market
Different types of fixed income securitiesFixed Income SecuritiesFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities. are traded in the fixed income market.
#1 – Bonds
Bonds are issued by the corporate and government to finance the business for expansion. If an investor invests in a bond, they will receive a regular 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., called “Coupon Payment,” and will get the principal amount on the bond’s maturity.
#2 – Treasury Bills
It is also a fixed-income security issued by the federal government with a maturity period of 1-12 months. This security does not offer any interest or coupon regularly but a discount at the time of the issue.
Example of Fixed Income Securities
Suppose A Ltd. issues 2-year bonds with $200 that pays 3% interest annually.
So, investors will receive $200*3%, i.e., $6 in the first year and ($200*3%+$200), i.e., $206 in the second year.
On the other hand, if an investor invests in treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government. whose face value (par value) is $200, investors will have to invest less than the face value of $185. Here, $15 will be treated as interest or fixed income.
The following are the criteria exist to classify fixed income market: –
#1 – Who is the Issuer of Fixed Income Security?
Government, corporate, and the finance sector can issue these securities. These sectors may have different coupon rates on issuing the bond.
#2 – Creditworthiness of the Issuer
The coupon rateCoupon RateThe coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100% or fixed income depends on the issuer’s creditworthiness (judged by a credit rating agency). If issuer credit is poor in the market, the coupon rate will be high on the bond issue. On the other hand, if the issuer credit is good, the coupon rate will be slightly lower than the old lower credit issuer bond.
#3 – What is the Maturity Period?
The maturity period of fixed income securities is different for different securities like money marketMoney MarketThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. bonds (maturity period till one year of the investment) and capital market bonds (maturity period more than one year).
#4 – In which Currency Securities are Issued
The majority of bonds are issued in Euro and US Dollars.
#5 – Type of Coupon Rate
Fixed income securities (bonds) are issued in two types of coupon rate, i.e., fixed rate of interest and floating rate of interest (it depends on market rates moving at the time of paying coupon like LIBORLIBORLIBOR Rate (London Interbank Offer) is an estimated rate calculated by averaging out the current interest rate charged by prominent central banks in London as a benchmark rate for financial markets domestically and internationally, where it varies on a day-to-day basis inclined to specific market conditions.+ SPREAD OR MIBOR +SPREAD).
- Regular Income: Fixed income securities will provide fixed income regularly, like monthly, quarterly, half-yearly, or yearly. In these securities, investors know what they will get on their investment and when they will get it.
- Less Risk: In fixed income securities, the risk is low because the return on these securities is not associated with market risks like shares or mutual funds. Therefore, it is helpful to investors who do not want to take a risk.
- Priority at the Time of Liquidation: In liquidation or insolvency,Insolvency,Insolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow., fixed income securities holders will be given priority over other securities holders.
- Interest Rate Risk: In a fixed income market, interest rate risk arises when the interest rate in the market increases, but the investors will not benefit because they will get the same amount of interest on which they have invested funds.
- Credit Risk: In the case of corporate bonds, if due to internal or external factors, the company position declines, it will also affect the bond price in the market. The bond priceBond PriceThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows. will also decrease, and if any bondholder wants to sell their instruments before maturity, they have to sell the equity at a lower value or may face difficulty in selling it.
- Inflation Rate: If the inflation rate is higher than fixed income securities, the fixed income market securities are not advisable because the investor will get the fixed income, which will not match inflation.
The fixed income market is suitable for both Investors and Borrowers because. In this market, the investor gets fixed income with significantly less risk (risk occurs due to default of the issuer and due to change in the exchange rate) and the borrower gets a good amount to invest in the business for expansion. It is different from stocks because here the borrower acquires money as debt and pays something in return for that debt and principal amount on maturity. The ownership right is also not transferred to the investor because of the nature of investments.
Frequently Asked questions (FAQs)
When a bond is deemed to be liquid, a market of investors actively buying and selling that type of bond is typically present. Larger issuance from reputable companies and Treasury bonds are typically more liquid.
Fixed income securities are ideal for people looking for safe and stable investments. It can also be chosen by avid investors to secure returns and diversify their portfolios as they receive a stable source of dividends.
Investors can purchase and trade financial assets that fall under the categories of equity and fixed income. Shares of stock are often referred to as equity, although corporate and government bonds are typically included in fixed income.
The fixed income market in India is jointly regulated by RBI & SEBI. The fixed income market in India is mostly dominated by banks and other institutions. Retail investors’ participation is almost negligible.
This has been a guide to what is the Fixed Income Market. Here we discuss the classification and example of the fixed income market and types of fixed income securities. You can learn more about it from the following articles –