Course Overview
In the past, fixed income(Bonds) were a relatively unnoticed component of the financial markets. Bond markets were utilised by affluent people, businesses, and even governments up until the late 1970s to store significant sums of money in low-risk, low-return instruments. These bonds were regarded as one of the safest investment options because they were typically issued by sovereign governments. Additionally, since the globe was on the gold standard, concerns about inflation and currency changes largely had no effect on the bond market.
However, in the ensuing decades, a lot has changed. It is crucial to understand that since the world has abandoned the gold standard, the government is now free to print unlimited amounts of money without having to provide any form of monetary backing. Depending on how the government chooses to respond, this may result in different inflation rates. Variable rates of inflation also translate into variable rates of return for fixed-income investors since inflation reduces the value given by fixed-income instruments. As a result, abandoning the gold standard transformed the gloomy fixed income market into a booming one where investors might profit greatly.
Types of Fixed Income(Bonds)
Investors immediately conjure up pictures of bonds when the term "fixed income securities" is spoken. This is a generalisation made by the investors, though. In truth, the term "fixed income securities" can be used to describe a wide range of assets. An investor needs to be knowledgeable about the various securities available, as well as their benefits and drawbacks.
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1. Treasury Bills
The world's safest category of fixed income instruments is Treasury Bills. Treasury bills really relate to the debt securities that the US government has issued. However, the phrase is frequently used to describe any sort of debt that a government has issued. Lending to governments carries very minimal risk because they have complete control over the nation's money supply. Due to this, a large number of risk-averse investors keep their money in this asset class.
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2. Bank Fixed Deposits
The next safest subset of fixed income instruments is bank fixed deposits. The maturity value of the assets is known to the investors well in advance, just like treasury bills. This explains why risk-averse investors like these investment vehicles. These large banks also ensure the security of bank fixed deposits.
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3. Corporate Bonds
Corporate bonds make up the following group of bonds. Corporate bonds fall lower on the creditworthiness scale than treasury bills and bank fixed deposits. However, there is a sizable market for corporate bonds. This is due to the fact that all businesses are attempting to raise money from consumers. Investors have a lot of options in this market because of this. They can decide to lend to prestigious blue-chip corporations where the likelihood of default is essentially nonexistent. Investors may, however, decide to put their money into businesses with weak financial standing.
Types of Coupon Rates in Fixed Income(Bonds)
Due to the consistent income they generate in the form of coupon payments, fixed income assets are crucial components of investors' portfolios. However, there are numerous different bond varieties on the market that offer various coupon payment options. These various coupon payment forms should be understood by investors because they might significantly affect their monthly cash flow.
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1. Fixed-Rate
A fixed-rate bond is the most basic type of coupon rate supplied by bonds. Since they are the most widely offered in the market, these bonds are frequently referred to as "plain vanilla bonds." The nominal interest rate on these bonds remains constant for their entire lifespan. For example, if the interest rate is 6%, the bond will continue to pay 6% for the duration of its life regardless of the market interest rate. Bonds with a fixed rate of return pay interest every two years. However, the interest may also be paid every month, every three months, or every year.
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2. Floating Rate
In contrast to standard bonds, floating rate coupon payments bonds have interest rates that are expressed in terms of a benchmark rate. The interest rate, for instance, could be written as LIBOR plus 2%. In this instance, the benchmark rate is LIBOR, or the London Inter-Bank Interest Rate, and the premium is 2%. The most popular benchmark rate for bonds used globally is LIBOR. However, it is also typical to utilise the benchmark rate as the treasury rates of national securities. The benefit of a floating rate coupon is that it offers inflation protection. Bond prices fluctuate up and down in lockstep with interest rates. As a result, investors continue to receive the same real rate of return.
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3. Zero-Coupon
Another type of coupon rates are zero-coupon bonds, which are typically provided by governmental organisations. These bonds don't pay any coupons during the course of their lifetime, as the name would imply. In other words, the bonds are initially sold for a substantial discount to their face value. Let's use an illustration to better grasp this. A five-year Treasury bond with a face value of $100 might be sold for as little as $60. As a result, the investor must deposit $60 up front and will get $100 at the conclusion of their investment. The bond would earn interest during the investment period, which would also be reflected in the market price of the bond. However, no actual payments, whether semi-annual or otherwise, would be made. Although these bonds don't pay any coupons, an implied coupon rate in the form of a semi-annual rate is nevertheless calculated for them. To make these bonds comparable to other bonds on the market, this is done.
