Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year, and to repay the principal amount on maturity. Fixed-income securities can be contrasted with equity securities - often referred to as stocks and shares - that create no obligation to pay dividends or any other form of income.
In order for a company to grow its business, it often must raise money - for example, to finance an acquisition; to buy equipment or land; or to invest in new product development. The terms on which investors will finance the company will depend on the risk profile of the company.
The company can give up equity by issuing stock, or can promise to pay regular interest and repay the principal on the loan bonds or bank loans. Fixed-income securities also trade differently than equities.
Whereas equities, such as common stock, trade on exchanges or other established trading venues, many fixed-income securities trade over-the-counter on a principal basis. The term "fixed" in "fixed income" refers to both the schedule of obligatory payments and the amount. If an issuer misses a payment on a fixed income security, the issuer is in default , and depending on the relevant law and the structure of the security, the payees may be able to force the issuer into bankruptcy.
In contrast, if a company misses a quarterly dividend to stock non-fixed-income shareholders, there is no violation of any payment covenant, and no default. The term fixed income is also applied to a person's income that does not vary materially over time. This can include income derived from fixed-income investments such as bonds and preferred stocks or pensions that guarantee a fixed income.
When pensioners or retirees are dependent on their pension as their dominant source of income, the term "fixed income" can also carry the implication that they have relatively limited discretionary income or have little financial freedom to make large or discretionary expenditures. Governments issue government bonds in their own currency and sovereign bonds in foreign currencies.
State and local governments issue municipal bonds to finance projects or other major spending initiatives. Debt issued by government-backed agencies is called an agency bond. Companies can issue a corporate bond or obtain money from a bank through a corporate loan.
Preferred stocks share some of the characteristics of fixed interest bonds. Securitized bank lending e. Investors in fixed-income securities are typically looking for a constant and secure return on their investment.
For example, a retired person might like to receive a regular dependable payment to live on like gratuity, but not consume principal. This person can buy a bond with their money, and use the coupon payment the interest as that regular dependable payment.
When the bond matures or is refinanced, the person will have their money returned to them. The major investors in fixed-income securities are institutional investors, such as pension plans, mutual funds, insurance companies and others. The main number which is used to assess the value of the bond is the gross redemption yield.
This is defined such that if all future interest and principal repayments are discounted back to the present, at an interest rate equal to the gross redemption yield gross means pre-tax , then the discounted value is equal to the current market price of the bond or the initial issue price if the bond is just being launched. Fixed income investments such as bonds and loans are generally priced as a credit spread above a low-risk reference rate, such as LIBOR or U.
The credit spread reflects the risk of default. If the coupon on the bond is lower than the yield, then its price will be below the par value, and vice versa. In buying a bond, one is buying a set of cash flows, which are discounted according to the buyer's perception of how interest and exchange rates will move over its life.
Supply and demand affect prices, especially in the case of market participants who are constrained in the investments they make. Insurance companies and pension funds usually have long term liabilities that they wish to hedge, which requires low risk, predictable cash flows, such as long dated government bonds. Some fixed-income securities, such as mortgage-backed securities, have unique characteristics, such as prepayments, which impact their pricing.
There are also inflation-indexed bonds , fixed-income securities linked to a specific price index. This means that these bonds are guaranteed to outperform the inflation rate unless a the market price has increased so that the "real" yield is negative, which is the case in for many such UK bonds, or b the government or other issuer defaults on the bond.
This allows investors of all types to preserve the purchasing power of their money even at times of high inflation. For example, assuming 3.
Fixed income derivatives include interest rate derivatives and credit derivatives. Often inflation derivatives are also included into this definition. There is a wide range of fixed income derivative products: The most widely traded kinds are:. Fixed income securities have risks that may include but are not limited to the following, many of which are synonymous, mutually exclusive, or related:.
From Wikipedia, the free encyclopedia. Foreign exchange Currency Exchange rate. Bond Debenture Fixed income. Accrual bond Auction rate security Callable bond Commercial paper Contingent convertible bond Convertible bond Exchangeable bond Extendible bond Fixed rate bond Floating rate note High-yield debt Inflation-indexed bond Inverse floating rate note Perpetual bond Puttable bond Reverse convertible securities Zero-coupon bond. Asset-backed security Collateralized debt obligation Collateralized mortgage obligation Commercial mortgage-backed security Mortgage-backed security.
Corporate Debenture Government Municipal. Default Insolvency Interest Interest rate. Retrieved from " https: Fixed income Fixed-income securities.