Fixed Income Market

Publication Date :

18 Mar, 2020

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Table Of Contents

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.

Key Takeaways

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 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 income, 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.

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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 bills 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.

Classification

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 rate 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 market 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 LIBOR+ SPREAD OR MIBOR +SPREAD).

Advantages

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,, fixed income securities holders will be given priority over other securities holders.

Disadvantages

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 price 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.

Conclusion

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.