We break down the basics of fixed income markets
Fixed income investing
Fixed income assets can play a useful role in an investment portfolio. As the name implies, these assets provide you with regular income payments. What’s more, they can also bring diversification to a portfolio that’s overweight in investments such as shares and property.
As with any investment opportunity, not all fixed income assets or the strategies for using them are alike. Here, we break down the fundamental attributes of fixed income assets and some of the ways they are used by investors.
Fixed income is an umbrella term describing investments that make regular contractual payments to investors over the asset’s lifetime and then return the capital at call or maturity. The term is most commonly applied to government, bank and corporate bonds.
Bonds are sold (issued) by governments, banks and corporations to raise capital and they operate like a loan. Issuers receive capital from investors and agree to pay regular interest over a pre-determined timeframe and pay back the capital when the bond matures.
Fixed income can be floating
The amount paid in interest can be fixed or floating. This payment is known as the ‘coupon rate’. Fixed coupons will not vary however floating coupons will adjust with underlying cash rates. Both are paid as a percentage of the principal balance and paid at regular intervals, 6 monthly for fixed, quarterly for floating rate.
Payments are made until the bond is called or matured, typically 5 years, at which point the bond’s owner is paid its face value.
Bond issuers are contractually obliged to make these regular payments. And because a bond is a loan, bond investors will be paid before shareholders receive dividends or if the corporation is liquidated.
Buying and selling bonds
Bonds can be bought on the:
Primary market from the corporation or government that issues it, or
Secondary market from a bold holder on the open market.
Once a bond is issued, the interest rate for fixed bonds and the coupon spread for floating bonds stays the same. So if interest rates increase existing fixed bonds will become less attractive to investors and the capital price will decrease. Floating bond coupons will increase by nature of being floating and the capital price will be more stable. Visa versa in a decreasing interest rate environment.
Interest rate movement
Change in Capital Price
Ten year bond
Floating rate note
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