Fixed income securities investing basics
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You can judge a fixed-income security on its price, its yield or its coupon. The price is straightforward, and can fluctuate between the time a bond is issued and when it matures. The coupon is the amount you get in regular payments.
The yield is the percent of the price that equals the coupon. So, if the price of your bond increases, the yield decreases. When you buy a fixed-income security you pay its face value. You then receive regular interest payments and if you hold until maturity you get the face value your principal back. If your security increases in price you have to sell it to realize that gain.
Interest Rate Risk: Another risk to holding fixed-income securities is interest rate risk. Interest rates and bond prices have an inverse relationship. When interest rates rise, prices of existing bonds fall. However, you are missing out on the opportunity to buy new bonds with a higher interest rate if your money is already tied up in securities you bought before interest rates moved. Price Risk: Fixed-income securities also come with price risk.
Securities have a time stamp. Exchange Rate Risk: Anyone holding fixed-income securities from a foreign country is vulnerable to exchange rate risk. If you own a security that pays out in a foreign currency, when the value of that currency falls you get less money. On the other hand, if the value of that currency increases relative to the dollar, your security becomes more valuable.
Credit Risk: Finally, some securities carry risk of default also known as credit risk. The company or government that issues the security could find itself unable to pay what it owes you, leaving you high and dry. Bonds are the most common type of fixed-income security, but others include CDs, money markets, and preferred shares.
Not all bonds are created equal. In other words, different bonds have different terms as well as credit ratings assigned to them based on the financial viability of the issuer. The U. Treasury guarantees government fixed-income securities, making these very low risk, but also relatively low-return investments.
The interest payments are typically made semiannually while the principal invested returns to the investor at maturity. Bonds are the most common form of fixed-income securities. Companies raise capital by issuing fixed-income products to investors. A bond is an investment product that is issued by corporations and governments to raise funds to finance projects and fund operations. Bonds are mostly comprised of corporate bonds and government bonds and can have various maturities and face value amounts.
The face value is the amount the investor will receive when the bond matures. Credit Rating Fixed Income Securities Not all bonds are created equal meaning they have different credit ratings assigned to them based on the financial viability of the issuer. Credit ratings are part of a grading system performed by credit-rating agencies. These agencies measure the creditworthiness of corporate and government bonds and the entities ability to repay these loans.
Credit ratings are helpful to investors since they indicate the risks involved in investing. Bonds can either be investment grade on non-investment grade bonds. Investment grade bonds are issued by stable companies with a low risk of default and, therefore, have lower interest rates than non-investment grade bonds. Non-investment grade bonds, also known as junk bonds or high-yield bonds, have very low credit ratings due to a high probability of the corporate issuer defaulting on its interest payments.
As a result, investors typically require a higher rate of interest from junk bonds to compensate them for taking on the higher risk posed by these debt securities. Types of Fixed-Income Securities Although there are many types of fixed-income securities, below we've outlined a few of the most popular in addition to corporate bonds.
Treasury notes T-notes are issued by the U. Treasury and are intermediate-term bonds that mature in two, three, five, or 10 years. The interest payment and principal repayment of all Treasurys are backed by the full faith and credit of the U. Another type of fixed-income security from the U. Treasury is the Treasury bond T-bond which matures in 30 years. Short-term fixed-income securities include Treasury bills. The T-bill matures within one year from issuance and doesn't pay interest.
Instead, investors can buy the security at a lower price than its face value, or a discount. When the bill matures, investors are paid the face value amount. The interest earned or return on the investment is the difference between the purchase price and the face value amount of the bill. A municipal bond is a government bond issued by states, cities, and counties to fund capital projects, such as building roads, schools, and hospitals. The interest earned from these bonds is tax exempt from federal income tax.
Also, the interest earned on a "muni" bond might be exempt from state and local taxes if the investor resides in the state where the bond is issued. The muni bond has several maturity dates in which a portion of the principal comes due on a separate date until the entire principal is repaid.
A bank issues a certificate of deposit CD. In return for depositing money with the bank for a predetermined period, the bank pays interest to the account holder. CDs have maturities of less than five years and typically pay lower rates than bonds, but higher rates than traditional savings accounts. In order to get the most out of this kind of security, be sure to do your research to determine what CDs offer the best rates currently available. Companies issue preferred stocks that provide investors with a fixed dividend , set as a dollar amount or percentage of share value on a predetermined schedule.
Interest rates and inflation influence the price of preferred shares, and these shares have higher yields than most bonds due to their longer duration. Benefits of Fixed-Income Securities Fixed-income securities provide steady interest income to investors throughout the life of the bond.
Fixed-income securities can also reduce the overall risk in an investment portfolio and protect against volatility or wild fluctuations in the market.
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