What are fixed-income securities?
Fixed-income securities or in other words fixed-income investments are investments that provide recurring payments, these periodical payments may be fixed in dollar terms or fluctuate based on a previously established calculation method. for example, if there is a rise in interest rates in the stock market this will result in a rise in cash payments. Some of the fixed-income securities Investments can offer a contractually guaranteed return involving a binding agreement between the borrower and the investors, where the borrower is obliged to make regular payments. When he fails to do so, he may be subjected to legal action, this means that the borrower, also known as the issuer of the security, is obligated to make regular payments to the investors. The borrower may face legal consequences when they fail to fulfill this promise. while other fixed-income securities come with a regular payment expectation even if there is no legal agreement to make the payments. This expectation is usually based on the borrower’s financial strength and past payment history.
Because of their relatively predictable cash payments, these kinds of securities tend to be popular among investors during times of economic instability and uncertainty when investors are afraid to invest in common stocks because of their higher risk compared to fixed-income investments and also during periods of high-interest rates in which fixed-income securities become appealing to investors who are seeking to secure high returns. The most widely used types of fixed-income securities are bonds, convertible securities, and preferred stocks.
Fixed-income investment:
Pros
- Consistent interest payments throughout the life of the bond.
- Capital preservation.
- Investing in fixed-income securities helps to diversify a portfolio.
- Liquidity.
- Predictability.
Cons
- Limited potential for capital appreciation.
- Inflation risk.
- Low returns compared to other types of investments.
- Credit risk.
- Sensitivity to changes in interest rates.
What are Bonds?
Bonds are an instrument for investors to lend money to governments or companies and corporations, they act as an agreement between the bondholder (the investor) or also known as the lender, and the borrower which can be a corporation or a government, the borrower promises to pay back the borrowed money over a relatively long period of time, commonly 10 to 30 years from the date issued, in return the bondholder receives regular interest payments and the full amount they loaned (also known as face value).
governments use bonds as a mean of funding their operations and projects and to supplement revenues from taxes.
companies issue bonds as a way to finance and fund ongoing operations or new projects.
Corporate VS Government Bonds:
In most cases, corporate bonds offer higher pre-tax returns in comparison to government bonds. However, this enhanced return with corporate bonds is accompanied by increased price volatility, rendering corporate bonds a riskier investment choice when compared to government bonds.
Government bonds offer certain advantages over corporate bonds. Notably, they come with tax benefits such as exemption from state and local taxes. Furthermore, they provide enhanced downside protection due to their stronger negative correlation with equities, which means that during market downturns, government bonds tend to maintain or increase in value, offering a protective cushion for investors.
Callable VS Non-Callable Bonds:
Callable and Non-Callable bonds represent two different types of fixed-income securities. Callable bonds, also known as redeemable bonds, give the issuer the right to redeem or “call” the bond before its maturity date. This feature provides flexibility for the issuer but can pose reinvestment risk for bondholders if interest rates have fallen since the bond was issued. In contrast, Non-Callable bonds lack this redemption feature, offering bondholders the assurance that the bond will remain in force until maturity, allowing them to collect interest payments as expected. Non-Callable bonds offer greater predictability in terms of cash flows, making them popular choices for conservative investors seeking stable income.
Bond Funds:
Bond funds, much like ETFs, pool together a variety of bonds into a single, accessible investment vehicle. Typically, these funds contain a diverse array of hundreds to even thousands of individual bonds. Investors are drawn to bond funds primarily for the advantages of diversification and risk reduction they offer. These investment products, sometimes referred to as bond ETFs, also present a user-friendly option for the everyday investor.
In contrast, if one were to consider purchasing individual bonds, they would encounter investment minimums, often commencing at $1,000, and would need to be prepared to cover associated fees and commissions. This approach is generally better suited for seasoned investors with substantial portfolios and the expertise required to select individual bonds, whereas bond funds are designed to cater to a broader and more accessible spectrum of investors.
Why use Bonds in a portfolio?
Investors often use bonds in a portfolio to diversify and obtain market downside protection. The negative correlation between bonds, especially government-issued bonds, and equities serves as an effective downside protection mechanism in a portfolio. This means that when equities experience price declines during market downturns, the value of government bonds, such as U.S. Treasuries, typically rises or remains stable.
What are convertible securities?
A convertible security is a unique and particular kind of investment that offers its holder a fixed-income return, convertible securities allow the investors to convert them into a specified number of shares of common stock, this kind of investment provides the benefits of bonds which is a fixed return (interest) as well as the possibility of making capital gains if the stock price goes up but some of the risks of this kind of investment is that price can go down too. Convertible securities have a maturity date in which the investors can choose between converting or receiving their investment.
What is a preferred stock?
Preferred stock, like common stock, indicates an ownership stake in a company and has no maturity date, unlike common stock, preferred stock has a fixed dividend rate, which provides the investors with a predictable income stream. This makes this type of investment an attractive option for investors seeking a stable source of income. Typically, companies are obligated to pay dividends on preferred shares before they can distribute dividends on common shares, additionally, if a company faces some financial difficulties and chooses to stop paying preferred dividends it must usually pay all of the missed dividend payments before disbursing dividends on common shares. In most cases, investors buy preferred stocks for dividend payouts, although these shares may also lead to capital gains. However, preferred shares tend to be less liquid than common shares and carry some risks related to dividend cuts or reductions.
