For many investors, particularly retirees, fixed-income investments are a secure, low-risk way to generate a steady flow of income. As long as they are held to maturity, fixed-income securities will provide a guaranteed return on your investment, with payments known in advance. A bond is an obligation or loan made by an investor to an issuer e. In turn, the issuer promises to repay the principal or face value of the bond on a fixed maturity date and to make regularly scheduled interest payments usually every six months.
The major issuers of bonds are governments and corporations. Savings bonds issued by the Canadian and various provincial governments are different from conventional bonds.
Canada Savings Bonds CSBs typically pay a minimum guaranteed interest rate there are also compound interest bonds available. A CSB carries no fees and is cashable at any time. The amount received for a CSB will never go below its face value if redeemed by the issuer, while the price received in the market for a conventional bond will depend on the level of interest rates at the time of sale.
In addition, only residents of Canada or of the province of issue are eligible to purchase CSBs, and only up to a predetermined amount.
A laddered portfolio is composed of several fixed income products with successively longer terms to maturity. For instance, in a year laddered portfolio, you might start by purchasing 10 bonds that mature in each of the next 10 years.
When the first bond matures at the end of year one, you would reinvest in a bond that matures in ten years — and continue doing this every year. Each position in a laddered portfolio is usually the same size as the next, with roughly equal intervals between maturity dates. You can create a laddered portfolio using bonds or GICs.
A laddered portfolio helps spread your reinvestment risk over the long term, helping to average out the effects of overall interest rate changes. For instance, if you only purchase bonds with short-term maturities you will have relatively stable bonds with lower returns.
Conversely, bonds with longer-term maturities are more sensitive to changes in interest rates, but offer higher yields in a normal yield curve environment. A laddered portfolio diversifies your exposure to the yield curve.
You realize greater returns than from holding only short-term bonds, but with lower risk than holding only long-term bonds. Moreover, by spreading out the maturities of your portfolio, you reduce the effects of interest rate changes. Investors are responsible for their own investment decisions. Used under licence. All rights reserved. Skip header Skip to main content. Understanding Fixed Income.
Fixed Income: The Basics. What are fixed income products? The yield is most affected by five key variables, discussed in detail below: Interest Rates Interest rates vary from market to market, and change over time in response to government lending rates and market conditions.
Duration The duration of a fixed income investment, expressed as a number of years, tells you how sensitive its price will be to changes in the market or benchmark interest rates. Duration Price sensitivity to a change in rates is… If market interest rates fall the price of the bond will go… The impact of rising interest rates on price will be… If market interest rates rise the price of the bond will go… The impact of falling interest rates on price will be… High High Up More Down More Low Low Up Less Down Less A longer maturity results in a higher duration while a higher coupon payment lowers duration.
Credit Rating Many fixed income products are rated by independent rating agencies that measure the issuer's creditworthiness or ability to make interest payments and repay principal.
The Yield Curve The yield curve graphs the relationship between interest rates and different maturities. The image shows a normal-shaped yield curve. In a line graph, interest rates are plotted against maturities. Longer maturity fixed income securities have higher yields relative to shorter maturity fixed income securities. Fixed Income Markets No two bond issues are exactly alike, and the number of different securities outstanding is substantial.
Bonds trade over-the-counter OTC on the bond market and secondary market. Fixed income investing is a conservative strategy where returns are generated from low-risk securities that pay predictable interest.
Since the risk is lower, the interest coupon payments are also, usually, lower as well. Building a fixed income portfolio may include investing in bonds, bond mutual funds , and certificates of deposit CDs.
One such strategy using fixed income products is called the laddering strategy. A laddering strategy offers steady interest income through the investment in a series of short-term bonds. As bonds mature, the portfolio manager reinvests the returned principal into new short-term bonds extending the ladder. This method allows the investor to have access to ready capital and avoid losing out on rising market interest rates.
When the second bond matures those funds roll into a bond that extends the ladder for another year. In this way, the investor has a steady return of interest income and can take advantage of any higher interest rates. As stated earlier, the most common example of a fixed-income security is a government or corporate bond.
The most common government securities are those issued by the U. However, many fixed income securities are offered from non U. Here are the most common types of fixed income products:. Fixed income investments offer investors a steady stream of income over the life of the bond or debt instrument while simultaneously offering the issuer much-needed access to capital or money.
Steady income lets investors plan for spending, a reason these are popular products in retirement portfolios. The interest payments from fixed-income products can also help investors stabilize the risk-return in their investment portfolio—known as the market risk.
For investors holding stocks, prices can fluctuate resulting in large gains or losses. The steady and stable interest payments from fixed-income products can partly offset losses from the decline in stock prices.
As a result, these safe investments help to diversify the risk of an investment portfolio. Also, fixed-income investments in the form of Treasury bonds T-bonds have the backing of the U. Should a company declare bankruptcy or liquidation, bondholders have a higher claim on company assets than do common shareholders. Although there are many benefits to fixed income products, as with all investments, there are several risks investors should be aware of before purchasing them.
When choosing an investment take care to look at the credit rating of the bond and the underlying company. Bonds with ratings below BBB are of low quality and consider junk bonds. The credit risk linked to a corporation can have varying effects on the valuations of the fixed-income instrument leading up to its maturity.
If a company is struggling, the prices of its bonds on the secondary market might decline in value. If an investor tries to sell a bond of a struggling company, the bond might sell for less than the face or par value. Also, the bond may become difficult for investors to sell in the open market at a fair price or at all because there's no demand for it. The prices of bonds can increase and decrease over the life of the bond. If the investor holds the bond until its maturity, the price movements are immaterial since the investor will be paid the face value of the bond upon maturity.
Your email. Message Optional. Government bonds are also known as Sovereigns and Treasuries. Governments issue bonds to pay for government activities and pay off their debt obligations. Low to moderate risk, depending on term length 1 year Government bonds typically have the lowest risk. Government agencies issue bonds to support their mandates, typically to ensure that various constituencies have access to sufficient credit at affordable rates.
Corporate bonds are also referred to as credit. Corporations issue bonds to expand, modernise, cover expenses and finance other activities.
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