What Is Fixed-Income Security?

Fixed-income security pays interest and refunds the principal at maturity. Fixed-income securities have predictable returns, unlike variable-income securities, which depend on an underlying measure like short-term interest rates.

Understanding Fixed-Income Securities

Fixed-income securities are financial products that provide investors with a fixed interest rate through coupons. Interest payments are typically made semiannually, and investors get their capital at maturity. Bonds comprise the majority of fixed-income securities.

Bonds are financial products that businesses and governments issue to finance operations and projects. Corporate and government bonds vary in maturity and face value. The investor receives the bond’s face value at maturity. Major markets list corporate and government bonds having $1,000 par values.

Companies raise cash through fixed-income product issuance to investors.

Fixed-income securities credit rating

Bond credit ratings depend on the issuer’s financial health. Credit ratings are a result of grading by credit-rating companies. These agencies assess business and government bond creditworthiness and repayment capabilities. Credit ratings assist investors in understanding investment risks.

Bonds can be investment-grade or non-investment-grade. Investment-grade bonds, issued by solid corporations with minimal default risk, have lower interest rates than non-investment-grade bonds. Non-investment-grade bonds, such as junk or high-yield bonds, have worse credit ratings due to the issuer’s potential for default. Junk bonds provide higher interest rates to investors due to their increased risk.

Fixed-income securities types

Treasury Notes

Treasury notes (T-notes) are intermediate-term bonds that the U.S. and Treasury issue with maturities of 2, 3, 5, or 10 years. At fixed coupon or interest rates, $1,000 T-Notes pay semiannual interest. The U.S. government creates Treasury bonds to settle obligations and guarantees interest and principal payments.

Treasury Bond

The U.S. Treasury issues 30-year Treasury bonds (T-bonds). TreasuryDirect auctions $10,000 in Treasury bonds.

Treasury Bills

Short-term fixed-income securities include Treasury bills. T-bills mature in one year without interest. Instead, investors purchase the securities at a discount or lower price than their face value. Investors get the bill’s face value when it matures. Investing the purchase price less the bill’s face value yields interest.

Municipal Bond

States, towns, and counties issue municipal bonds to fund capital projects, including roads, schools, and hospitals, often with a $5,000 face value. Federal income taxes are waived on bond interest. The investor in the state where a “muni” bond is issued may be free from state and local taxes on its interest. The muni bond has numerous maturity dates, from when part of the principal is due until it is paid in full.

Certificate of Deposit

Banks provide certificates of deposit (CDs). Account holders receive interest for depositing money with the bank for a set time. CDs pay lower rates than bonds but are better than savings accounts for maturities under five years. Up to $250,000, every CD holder is FDIC insured.

Corporate Bonds

Companies raise capital via corporate bonds. Bond investors, unlike stockholders, lack voting rights and equity in the firm. Bonds are categorized by maturity. Short-term bonds last less than three years, medium-term bonds last four to 10 years, and long-term bonds last longer than ten years. Company credit ratings determine investment- or non-investment-grade bonds.

Preferred Stock

Companies offer preferred stock to investors, offering a fixed dividend amount or percentage of share value on a predefined timetable. Due to their longer tenure, preferred shares yield more than most bonds and are affected by interest rates and inflation.

Fixed-Income Securities Pros and Cons

Advantages

Investors benefit from stable interest income from fixed-income assets, which decrease portfolio risk and safeguard against market changes. Equities are more volatile than bonds. Therefore, investors may invest some of their portfolios in fixed-income securities to reduce risk. Mutual funds and exchange-traded funds provide fixed-income assets.

Bond and fixed-income prices fluctuate. Fixed-income securities provide predictable interest payments, but their prices may change. Investors who sell a fixed-income asset before maturity lose or earn the difference between buying and selling costs.

Federal government fixed-income securities are haven investments that the Treasury guarantees. Company finances determine corporate bond default risk, which is higher than that of government bonds. Since bondholders are reimbursed before ordinary stockholders, corporate debts are more likely to be repaid in bankruptcy.

Disadvantages

Fixed-income instruments can offer modest returns and delayed price growth. The initial principle amount is typically unreachable, especially for bonds over ten years old.

Fixed-income securities provide interest independent of market rates. An investor who bought a 2% bond will lose income if rates increase by over 4%. If inflation is higher than the interest rate on fixed-rate assets, it may reduce their return.

All bonds carry credit or default risk since they depend on the issuer’s finances. International bonds may have a higher default risk if the country is economically or politically unstable.

Pros

• Fixed-income securities provide investors with interest throughout their lifespan.
• Rating agencies rate fixed-income securities.
• Low price volatility is typical of fixed-income instruments.
• Treasury bonds are government-guaranteed.

Cons

• The issuer might miss interest or principal payments.
• Other investments yield higher returns than fixed-income securities.
• Inflation risk exists if prices grow faster than the fixed-income security’s interest rate.
• Market interest rates may exceed fixed-income security rates.

Fixed-Income Security Actual Example

Long-term Treasury bonds mature after 30 years. Semiannual interest payments are made on $1,000 T-Bonds. On February 15, 2023, a 3.625% 30-year Treasury bond was issued. Yearly returns on $1,000 investments are $36.25. Repaid in 30 years, $1,000 principle

A 3.5% 10-year Treasury note was released on February 15, 2023. Usually $1,000, the bond pays semiannual interest at specified coupon rates. Each bond pays $35 annually until maturity.

How can investing in fixed-income securities

TreasuryDirect lets investors buy U.S. government bonds. Corporate bonds or bond funds can be purchased via a financial broker. Financial brokers or banks sell CDs.

What Are Fixed Income Investment Risks?

Fixed-income instruments need long-term investments, often up to 30 years. The investment may lose money if market interest rates rise beyond the security’s fixed income rate. Inflation can also affect fixed-income securities.

Fixed-Income Security Default: What Does It Mean?

Default occurs when a loan or security owner fails to pay interest or principal. Individuals, corporations, and nations can default on debt.

Bottom Line

Fixed-income securities provide regular interest payments for a set time. Types include government, corporate, and fixed-income ETFs. Credit agencies score fixed-income assets for investor default risk. These investments have lower returns than others.

Conclusion

• Investors receive fixed-interest payments and principal at maturity with fixed-income instruments.
• Bonds are the most prevalent fixed-income security.
• Based on the issuer’s financial sustainability, bonds have varied terms and credit ratings.
• The U.S. Treasury insures government fixed-income securities, making them low-risk, low-return investments.